High investment rates, low wages, export-oriented strategies and progressive market liberalisation are some of the main ingredients of China’s unique and fast-paced growth that lasted almost twenty years.
Now, tighter monetary policy and attempts to avoid price bubbles, especially in the estate market, are all hints of a slowdown in China’s economic growth.
Possible Outcomes for 2017
A fall in the price of the renminbi against the dollar last November, in part following the US presidential election, made the Chinese Academy of Social Sciences forecast a yearly growth of 6.5%, 0.3 points below last year.
Despite a predicted increases in both import and exports figures from to 2% to 4%, and 4% to 6% respectively, according to the Chinese Ministry of Commerce, the renminbi is expected to further depreciate against the dollar by 3% to 5% after the 7% loss in value last year.
Instead, for Li Wei, an economist at the CBA, believes that China’s economic performance this year will depend on the global recovery: if exports to the US and the EU recover as predicted, China’s economic growth in 2017 has the potential to reach 6.8%.
Last year’s new house prices rose by a record 12.6%, and this figure is expected to rise further this current year, supporting economic growth, but still posing risks of speculative rallies, thus being a source of high concern for regulators.
The bullish performance in the bond market in 2016 is mainly due to relatively weak economic fundamentals, fast opening up of the market to all kinds of investors, innovation in bond products and consequent all time high issuances of green and panda bonds.
These factors created an increase in risks of default (53 bond defaults in ten months), spurring risk aversion among many investors. This emerged especially during the last quartile of 2016, with amplified concerns over liquidity stress, and with losses of around 1% in the price of China’s 10-year treasury futures for March delivery.
China’s foreign exchange reserves fell $12.3bn, to $2.998trn, but these figures do not take into account the borrowings outside China that may bring reserves down to $1.7trn.
According to Marketwatch, this amount cannot be enough to support the current pace of the renminbi exchange rate, not to mention a possible bust of the credit bubble. Analysts at HSBC pointed out that low domestic investment and increasing capital outflows are due a loss of confidence in the domestic economy. The main objective of policymakers should now be managing risk instead of focusing on growth targets.
Moreover, it should be noted that the debt-to-GDP ratio is about 400%, a figure that was around 100% seventeen years ago. If a 6.5% yearly growth is still sufficient to meet China’s objective to double its GDP and per capita income by 2020 compared to the 2010 levels, it should consider increasing the level of borrowing, especially after last year’s decelerated growth.
The current pace of total financing may not be fully sustainable in the long term, and together with a lower growth can result, worst-case scenario, in a burst credit bubble.
Why Slower Growth Isn’t Bad News
Research by Morgan Stanley pointed out that the crisis can be avoided for three main reasons:
- China’s debt has been funded through the country’s own savings, and it has supported new investment rather than consumption;
- Strong foreign and internal net asset positions can minimise any shocks;
- China can freely manage its domestic liquidity conditions thanks to a lack of high inflationary pressures, significant reserves of foreign currency reserves, and a current account surplus.
According to the Bank of China’s Economic and Financial Outlook for 2017, growth will stabilise during the year, especially thanks to the improved manufacturing sector, since last year was characterised by rebound of product prices, increased company profits and improvements made in tackling excess capacity. Consumption is also bound to increase, despite new regulations in the real estate sector and the car industry.
The Shift in China’s Economic Policy
Still, the rapid expansion of credit and lagging progress in addressing corporate debt, especially of state-owned enterprises, will increase the chances to go through economic slowdowns and disruptive adjustments. For this reason, the country’s central bank announced it would undertake a more neutral stance, and analysts at Reuters predict a raise in interest rates to both improve credit conditions and support the falling value of the renminbi, a prediction reinforced by the 3% inflation target for this year.
On the other hand, tighter credit can cause problems for market liquidity and debt prices, meaning that a careful balance of financial policies is needed to promote sustainable and beneficial growth, especially in the long term.
The focus of Chinese policymakers should not be growth per se, but the risks of unemployment and a debt crisis related to it. As Helen Zhu, head of China’s equities at Blackrock said, the quality of growth is much more important than the quantity.
This is positively reflected by the Morgan Stanley forecast that the country’s increasing shift in high-value manufacturing and services will increase national per capita income from $8,100 to around $12,900 in the next decade, thus becoming officially a high-income country as compared to the World Bank’s official benchmark of $12,500.
In conclusion, this is one of China’s latest stages of transition from an export-oriented and led by investment economy, to a system more dependent on internal consumption. Without any doubt, China will be if not first, the second biggest economy in the world for decades to come.