Country Report China
Growth in China is rebounding but, unfortunately, still driven by investment growth on the back of government stimulus and credit growth. The government thus still prioritizes on short-term growth, which makes implementing reforms a difficult task.
Strengths (+) and weaknesses (-)
(+) Strong growth potential
China’s GDP per capita is still relatively low and large parts of the country still need to be developed further. As a result, GDP growth is expected to remain strong, although policy reforms will be needed to sustain growth in the longer term.
(+) Exceptionally strong external (liquidity) position
China’s vast amount of FX reserves, amounting to USD 3,331bn end-2012, and low external debt give it an exceptionally strong external creditor position. External liquidity risk is very low.
(-) Growth model is unsustainable
China has to change its growth model and increase market forces in its economy to reduce inefficiencies and ensure sustainable growth in the future. However, China has so far lagged in the implementation of many vital reforms to make growth sustainable.
(-) Weak accountability of the government
High levels of corruption, weak protection of human rights, strong influence of the Chinese Communist Party on the judiciary and lack of democracy implies that the Chinese population cannot hold the government accountable for its actions, which increases the risk of public unrest.
1. Growth rebounds in the summer
In both 13Q1 and 13Q2, real GDP growth weakened, to 7.7% and 7.5% yoy, respectively. The new Chinese leadership appears focused on implementing the necessary economic reforms to make growth in China sustainable in the longer-term, tolerating lower GDP growth in favor of reforms. This tolerance has its boundaries, it turned out: when growth threatened to slow too much, the government implemented a stimulus package mid-2013. Investments in railways were increased while small-and medium-sized enterprises and the export sector benefitted from tax breaks. As strong credit growth in the first quarter also started to work through to the real economy and export growth picked up as well, monthly indicators improved in the months after June (see figure 1). On the back of renewed strong credit growth, the continued positive impact on growth of the stimulus package implemented before the summer, growth, although unfortunately still mainly driven by investment growth, is expected to be relatively strong in 13H2.
Real GDP growth in FY 2013 is therefore expected to come in either on or perhaps slightly above the government´s growth target of 7.5%. In 2014, China´s growth rate will largely depend on the government´s commitment to and success in implementing reforms, which will become clearer when the government´s economic reform plans are revealed in November. Assuming that reforms will be incremental but significant, growth is expected to slow slightly to about 7.3%.
2. Economic volatility shifts government back in forbearance stance
Among the most pressing problems that have to be addresses are the risks in the banking sector. To rein in the strong growth of wealth management products and other forms of alternative means of financing that carry more risk and are largely unsupervised by the regulatory authorities, the central bank sent a 'warning' to banks in June. The central bank tightened liquidity in the market, meant to bring liquidity risks within the banking sector to the surface. As a result, the overnight SHIBOR rate shot up to 13.4% and one bank allegedly experienced payment problems.
It appears that the authorities had underestimated the impact of the 'warning', though, and quickly returned to providing liquidity to the market. Since, the o/n SHIBOR rate has fallen steeply, although it settled at a higher rate than before the event. The episode and its aftermath are worrisome as it showed that the debt stock has become so large that the impact of reforms, or in this case even the warning of reform, can lead to major volatility. As the government wants to keep the economy growing in a stable manner, this means that it will be difficult to implement real reforms. Furthermore, showing it prioritizes on supporting short-term growth, the government has reverted back to a forbearance stance after the event. All types of credit grew rapidly again, indicated by the strong credit growth in August following four months of slowing credit growth. This will help short-term growth, but implies longer term problems remain unaddressed. If the government upholds this short-term focus, we fear that other vital reforms will also be insufficient to make real changes to China’s economic model.
3. Ambitious anti-corruption campaign continuous
President Xi Jinping has continued his ambitious anti-corruption campaign, with a slate of high-ranking officials being charged and sentenced. For an important part, the campaign targets Bo Xilai (sentenced to life in prison in September) and his allies, the neo-leftist former Party Chief of Chongqing and can thus be seen as a form of political cleansing. However, given the high public profile of the campaign that has scared many officials on all levels into less corrupt practices, it also seems to be aimed at actually addressing China’s serious corruption problem.
China is the second-largest economy in the World - after the US - measured in both nominal GDP (USD 8.35bn) and in PPP terms (USD 12.6bn). At the heart of China’s economic success has been its successful export- and investment-led growth model. Even though China has become the World’s second-largest economy, per capita income is still relatively low. Hence, strong economic and income growth are still badly needed. However, the advantages that supported China’s growth model, such as low wages and an undervalued currency, are diminishing, thereby hurting China’s international competitiveness. Meanwhile, adverse side effects, such as a rapid rise in income inequality and major environmental problems have become too big to ignore. China’s growth model will have to be changed and become more consumption-driven instead of investment-driven. Innovation will have to be nurtured, while environmental responsibility will have to gain in importance. The 12th 5-year plan, launched in March 2011, tackles these issues. However, implementing the plan correctly and timely will be a key challenge for Chinese authorities while major downside risks, such as a sharp economic slowdown or public unrest are present.
The People’s Republic of China, established in 1949, is a socialist one-party state ruled by the Chinese Communist Party (CCP). Power is centralized in the CCP and the support of the People’s Liberation Army and a well-developed internal security system safeguards political stability. The availability of information is heavily controlled by the government. Press freedom and freedom of speech are heavily restricted, while the judiciary is not independent. As a result, developments in China, especially political ones, remain clouded and difficult to gauge due to lack of transparency.