China: how realistic is the government’s growth target?
- China’s economic growth on government’s track in 2016, but lower growth expected ahead
- Government’s 2017 growth target set at ‘around 6.5%, or higher if possible’
- Reaching this target is a clear challenge, as focus will rely more and more on risk prevention amid excessive credit levels and capital outflows
- Cooling housing market additionally weighs on growth outlook
- US protectionism and security focus on China still an external downside risk
GDP growth target met in 2016, lower expected growth ahead
China’s Gross Domestic Product (GDP) posted an average growth rate of 6.7% in 2016, thereby achieving the minimal 6.5 percent growth target in its 13th five-year plan. Our China GDP proxy, the Rabobank China Activity Indicator (CAI), shows that overall the average growth in 2016 was significantly lower, but picked up in 2016H2 (Figure 1). The sustainability of the observed growth pick up, however, is questionable, as it was achieved to a large extent by a significant increase in leverage combined with fiscal and monetary stimulus. These measures helped stabilising growth, but medium to long-term risks have not been lowered. Despite government effort to lower overcapacity in some traditional sectors, such as coal and steel, inefficiencies in some other sectors characterised by large State Owned Enterprises remain high. China’s transformation from an investment and export-led growth model in favour of consumption and services shows mixed results and there is much room for improvement on all areas.
For 2017, we expect growth to average 6.3% amid a reduction in excessive lending, as policymakers are expected to shift their focus on containing risks and stability in view of the upcoming Party Congress in 2017H2. Over the weekend, at the start of the National People’s Congress, Chinese Premier Li Keqiang announced the official ‘around 6.5%’ GDP- target for 2017, but realisation of this is highly questionable in our view since aiming for such an ambitious growth level whilst also looking to lower economic stimulus and leverage at the same time would seem contradictory. After 2017, growth is expected to slow further in 2018 on the back of lower stimulus and protectionist trade measures by the US.
Leverage keeps on rising…
The significant increase in leverage is clearly visible in the rise of total credit-to-GDP levels, which increased from 231% end-2015 to 255% during 2016 (Figure 2). The reason for this surge was directly related to a stimulus package consisting for example of more and cheaper access to financing for commercial banks, thereby reducing borrowing costs for clients. Chinese policymakers recognise the potential problems of high debt levels and stepped up efforts to maintain financial stability and slow the overheated housing market in the past months. This will be at the expense of economic growth, as the reliance on easy credit is reduced.
…which creates negative externalities on the housing market…
Risks surrounding China’s housing market are increasing as housing prices have been rising sharply, although there has been some cooling down recently (Figure 3). The surge in real estate prices is only partly justified by economic fundamentals, such as the continuing rate of urbanisation, rising disposable income levels, and cultural values that favour property holdings (Erken et. al, 2016). Estimations show that there is a housing bubble in several Chinese cities, together covering roughly 12% of China’s urban population (Erken et. al, 2016). If the real estate market would collapse in the bubble areas, GDP growth would face downward pressure as the reduction of property sales will additionally weigh on economic growth via for example lower fixed (real estate) investment and private consumption related to housing sales.
…and together lead to more curbing measures
It is expected that the property market will continue to cool further amid existing measures to restrict home purchases and to rein in mortgage lending. On the internal side, China wants to temper rapid credit growth and curb potential asset bubbles, especially in housing market. The People’s Bank of China (PBoC) recently adopted a more tightening monetary stance, raising interest rates for various lending tools such as its Medium-term Lending Facility and reverse repo agreements.
On the external side, they want to limit capital outflows, as the surge in capital outflows puts pressure on China’s exchange rate (CNY). China’s foreign exchange (FX) reserves fell by almost 10% in 2016 to USD 3trn (Figure 4). The decline in FX reserves was related to the PBOC’s intervention to counterbalance the yuan depreciation against the US dollar. But there are limits to their intervention. China’s USD 3trn of FX reserves is IMF’s so called reserve adequacy metric of USD 1.8trn, as long as capital controls remain in place. At this level, the Chinese economy is expected to be able to deal with balance of payments strains. But if downward pressures on outflows continue, China will need more tightening of capital controls or must allow their currency to depreciate at a faster pace against the USD.
Other risks are looming externally
External risks are tilting towards the downside as well. For example as a result of protectionist trade policies by the US, which initially would harm China, since the US accounts for approximately 20% of China's domestic value added exports (Figure 5), which is equivalent to almost 4% of Chinese GDP. During his election campaign US President Trump additionally has suggested to bring an anti-China trade case to WTO and called China a currency manipulator. And any miscalculation by Trump on matters around security in the South China Sea or even increased military presence in South Korea could spark a hard line response from China, which could lead to a greater level of militarization and, consequently, political and economic uncertainty for the global economy.
Thus far, however, the actions of Trump’s administration towards China have been balanced. On the one hand, the influence of the internationalists in his team (Mattis, Kushner and Tillerson) might lead to a more balanced approach, as suggested by the Trump’s recent confirmation of China’s “One China” policy. On the other hand, the appointment of ‘China-hawks’ Navarro, Lightizer and Ross as trade representatives, highlights America’s more aggressive trade stance towards China (Prins, et. al, 2017). But not all Trump’s actions are on the negative for China. The US withdrawal of the Trans-Pacific Partnership (TPP) has given China, which was excluded from TPP, opportunities to step in and to expand its influence in Asia (Giesbergen and Hayat, 2017). The Regional Comprehensive Economic Partnership (RCEP) is generally regarded as an alternative, but the economic benefits from RCEP are not expected to be as large as those from TPP, especially for ASEAN countries, due to its pure focus on tariff barriers instead of including non-tariff measurements.