March 5, 2015    4 minute read

Chinese Challenges and the “New Normal”

   March 5, 2015    4 minute read

Chinese Challenges and the “New Normal”

To say that China’s sustained high growth in GDP has been well documented would be an understatement. The country has enjoyed some of the fastest growth rates in the world since the reforms of Deng Xiaoping in 1978, and, despite the international sanctions imposed on it after the Tiananmen Square Massacre, is credited in 2014 to have overtaken the USA as the world’s largest economy. 2015, however, looks to be a year of transition.

The announcement in the Chinese Parliament from Premier Li Keqiang that China would be targeting a growth rate of 7%, a far cry below the 10% rate that was averaged in the 30 years before 2010, came to many as no surprise. Indeed, some have said that this slowdown is inevitable. The credit-fuelled growth model that the country has been using has led to huge economic imbalances, particularly with regard to the housing boom that has recently shown signs of a slowdown. Further, the reliance on low wages has been undermined by the countries’ approach to middle-income.

None of this is surprising to investors, and certainly not the Chinese policymakers, with Mr Li claiming that “China’s economic development has entered a new normal.” What does this “new normal” entail? Surely it involves confronting the issues that are at the moment proving detrimental to the Chinese economy.

What are these issues?

First, policymakers must ensure that the growth slowdown does not happen too quickly. The figure of 7.4% posted in 2014 was its lowest for nearly a quarter of a century, and, with the country posting rates of only 7.7% in 2012 and 2012, there is no reason to expect that the growth will pick up pace in the next couple of years. Indeed, if the economy is to shift, policy must focus on making this transition as smooth as possible. The slashing of interest rates by the People’s Bank of China (PBoC) in November should be welcomed, as it went along way to curb staggering growth. However, as authorities have stressed, the slowdown in growth is surely inevitable with regard to the normalisation of the economy. Acting too drastically would be a grave error.

Second, the slowdown of the housing market must be treated with caution. Large Chinese cities experienced a 4.3% drop in the prices of its new homes, reinforcing the continuing fall that begun at the start of last year – a fall that reflects the imbalance of investment over saving that fuelled the boom in house prices and subsequent oversupply that is causing such a downturn. Thankfully, the consequences of this bearish housing market are certain to not be as marked as those that caused such a great financial crises in the developed world in 2008. Figures indicating a lower growth of GDP can, however, partly be attributed to this slowdown, and should therefore not be taken lightly by policy-makers.

Speculation that Chinese growth would continue to be at levels of around 7% practically indefinitely has been refuted by such recent developments. Indeed, although the PBoC has indeed targeted 7% for this year, there is no reason to believe that growth forecasts in the medium-long term will not be revised down to at least resemble those of developed countries in the rest of the world. China’s previous growth model relied on low wages; however, real wages are beginning to show signs of increasing towards middle income. Further, China had previously relied on its export sector to boost growth, yet it recorded a $66m current account deficit in Q4 2014 – only its 2nd quarterly deficit since 1998. This reflects a sluggish world economy, something many believe is likely to persist into at least the medium term.

Chinese troubles, therefore, look to show no signs of abating. However, the extent to which these are even “troubles” is debatable; are we not seeing the inevitable move towards a “new normal” that has previously been predicted? This is most likely to be the case. The transition to this normal is nonetheless fraught with difficulties, and not only the Chinese economy, but also the world economy, needs to be aware of the potential dangers.

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