China’s Economic Growth: Quantity over Quality
By: Katerina Hoskova, CASE Analyst
In 2012, the National Congress of the Communist Party of China (NCCPC) has set a goal of doubling the 2010 GDP (10.6%) until 2020 to not only celebrate the 100-year anniversary of the NCCPC, but also to accelerate convergence with the USA, the biggest economy in the world. However, China has faced a slowdown since 2015. Hence, the policy makers have been tenuously trying to nurture the economy to fulfill the quotas of the party. As a result, the economy is flourishing on the outside, but remains malignant on the inside.
Based on the International Monetary Fund’s (IMF) Chinese country report, the Communist Party of China (CPC) can be pleased with the current development of the economy. The IMF predicts that GDP will grow faster than expected, resulting in an increase of the IMF forecast from 6.2% to 6.7% in 2017, with a corresponding increase in average GDP growth from 6% to 6.4% over 2018–2020. However, the problem facing China is that its recent growth is of an “artificial” nature, as the government and the People’s Bank of China (PBOC) have been purposely trying to stimulate the economy to reach the target, not caring about the quality of the economic output. Although, as the experience of communist economies in the 20th century shows, this approach might deliver numbers in the short run, in the long run it is unsustainable.
The fuel for this growth has been a steadily-growing debt, creating vulnerabilities for the Chinese government, as well as a lack of fiscal space in the case of a crisis. From 2008 to 2016, China’s total debt quadrupled to the level of EUR 24 trillion. If the government keeps following this path and level of growth, it is expected that the debt-to-GDP ratio will grow from 235% to 300% by 2022. Such rapid growth is nowhere near sustainable, and without a correction, the economy would have to wean itself off of easy debt; this will be a true challenge for the credit-fueled economy.
However, not only the PBOC, but also President Xi Jinping himself is aware of the situation. The central bank stated that there is a need to stabilize the overall debt level and that it is ready to do so by using their own policy tools, while the President said that not only smaller banks and big private-sector companies, but also local government authorities and state owned enterprises (SOE) should be targeted. Although the positive economic outlook makes deleveraging attainable, achieving such a goal in a country which has been borrowing for decades to fund growth will be tricky. In particular, SOEs have been borrowing lavishly to sustain their otherwise mayfly life. For this reason, SOEs are on the top of the agenda, proposing various solutions such as consolidation of SOEs into a medium-sized group of national champions, partial privatization, forced bankruptcy of “zombie companies” or debt-for-equity swaps.
On August 23, brand new policies were introduced by the Premier to encourage deleveraging in the SOES, who saw combined profits grow by 16.4% y-o-y in the first seven months of 2017 (contrasted with a fall of 3.7% in the same period last year). State-owned enterprises will be reined in from new business activities to control debt, while companies which see profits growing will be forced to retire debt. Additionally, debt-for-equity swaps will be prioritized along with other new market-based swap models, and entities using swaps will be granted support to enlarge their funding channels.
Even though soaring debt is the biggest problem of the economy, it is not the only one. Chinese savings are very high, accounting for 46% of GDP, 26% points above the global average in 2015, but private investment in the economy remains stubbornly low. This points to major inefficiencies in the financial sector and an inability to translate savings into tangible investment. Moreover, savings rates are kept high by other policy failings, with low government social spending on health and pensions commensurate with China’s income levels. Indeed, by streamlining the tax system, the government might be able to spend more on social protection, shrinking the inequality which is one of the highest in the world (the richest 1% owns one-third of the country’s wealth, a reality attributed to the pervasive nature of politics in China’s economic system).
China’s policymakers seem to be aware of the rot at the heart of its economy and appear to be making plans to ameliorate the situation. However, the longevity of these policies may fail under sustained political pressure, as the communist need for growth and ground-breaking figures will likely prevail over sensibility. If the Chinese policy makers fall prey to their ideology, a growth engine of the global economy will be on the verge of breaking.