A Soft Landing for China's Economy
China's economy has been confronted with a growing list of uncertainties - from the exchange rate to property prices to surplus capacity in key industries. The big issue is the pace of economic growth,and if the economy can make a "soft landing," other problems can be addressed more easily.
In assessing the state of the Chinese economy,we need to examine the economic cycle,the economy's structural framework and the external environment.
If we look at where we are in the economic cycle,we note that there was considerable downward pressure on the economy in 2014 and 2015. This was particularly evident in the important property sector,where investment surged 20% in 2013,but then saw growth slip to 10% in 2014 and only 1% in 2015,. This had a huge impact on investment overall and economic growth.
After the massive 4 trillion yuan stimulus program that was rolled out after the financial crisis,there was a huge huge rebound in China's economy,with growth reaching double digit levels in 2010. This was followed by the beginnings of a structural adjustment which resulted in less robust demand overall and surplus capacity,particularly in industries such as iron and steel,coal and cement.
In 2015 and 2016,global demand was sluggish. In general,growth continually failed to meet market expectations during this recovery period. The EU maintained limited growth while the US economy,which was widely perceived as making a stronger rebound,actually failed to meet expectations and led many observers to reassess their outlook. This sub-par performance has held back China's exports and cut into the nation's economic growth.
Policy Boost for Economic Growth
There are some bright spots,however. First of all,since the fourth quarter of 2014,policy measures aimed at boosting the economy have achieved results. China has made greater use of fiscal stimulus and it has eased controls on the property sector. Since the fourth quarter of 2014 there have been six cuts in interest rates and six reductions in the bank reserve requirement. Along with the greater fiscal assistance,there has been an acceleration of infrastructure investment,and since March of 2016,the effects of these policies have been evident in the improved economic data. Thus,it can be seen that the economic cycle is becoming more favorable to growth.
Second,there have been positive developments on the structural side. The structural reforms of the last three to four years have produced a number of positive changes. Even though the results are not entirely satisfactory,the structural overhaul has led to a significant expansion of the tertiary sector,which has seen its contribution to GDP rise to more than 56%. Meanwhile,consumption now accounts for more than 60% of GDP.
For some regions,surplus capacity is a major drag on economic activity,but there are a number of provinces that still have relatively rapid growth. Meanwhile,there are sectors where the structural transformation is particularly obvious. The high-tech sector,the production of high-end equipment and consumer-related manufacturing are all demonstrating an ability to upgrade successfully. Some experts contend that China is benefiting from a concentration of technological innovation,and this will promote further upgrading of industry in the future.
As far as the external environment is concerned,the picture is less positive. Britain's decision to leave the EU,with support from close to 52% of the nation's voters,has resulted in uncertainties for the global economy,especially the UK and the EU overall. For China,the negative effects will emerge gradually. In the past,China relied on the United Kingdom,which embraces open market policies,to influence the actions of the EU. In the future the UK will no longer be able to play this role. There also are many Chinese enterprises that have viewed the UK as a springboard to the European market but this will not be the case in the future. They may no longer use the UK as a base for investment,trading and the management of their European operations. However,the UK may look for support from closer ties to markets outside the EU,especially the large developing economies. In this respect,China's enterprises and financial institutions may see more favorable UK policies in terms of investment,trade and mergers and acquisitions.
Britain's decision to leave the EU may create some opportunities but overall it will result in a lingering negative impact on the world economy. This makes the outlook for China in the second half of the year somewhat less promising.
Exports and Data Analysis
China's exports will retain their competitiveness,however,despite the difficult environment. Over the past two years,China's combined imports and exports have continued to see slower growth. The exchange rate had a bigger impact on exports while weaker commodity prices have had a big impact on import values. If we look at import volumes,however,there has been steady growth in imports of key commodities. In 2014 and 2015,China's trade surplus continued to expand.
China's exports have taken a growing share of the global market over the past two years,demonstrating that the nation's exports are still competitive. According to the author's own calculations,in 2015 China's exports accounted for 13.79% of the world total,similar to China's GDP as a proportion of the world GDP.
Over the past two years,China's investment has been on a steady decline. In 2014 and 2015,real estate investment was weak while infrastructure investment showed a slight decline overall interrupted by periodic upturns. Investment in fixed assets and by the manufacturing sector have seen downturns with the weakness becoming even more apparent this year.
Investment Growth
In 2014 and 2015,real estate investment had the biggest negative impact on investment. Real estate investment accounted for about one-fifth of fixed asset investment overall,but it accounted for about 40% of the total if we include indirect investment. This year,real estate investment rebounded significantly,gaining 6% - 7% over last year,higher than market expectations for a 3% - 5% rise. Manufacturing investment dropped significantly,in line with the decline in private investment. Private investment mainly went to the manufacturing sector,which accounted for about 45% of the total,followed by investment in real estate and the service sector. At the same time,much of the activity in construction is linked to the real estate business - from residential to commercial construction. Despite the fact that growth in construction investment was not low,most of the growth came from state-owned enterprises,while investment from the private sector fell sharply.
If we look at this sharp fall in private investment,we see the "crowding out effect" in the financing as one possible explanation. State companies snapped up bank credits,making it harder for private firms to get loans. But this is not the full story as state banks are normally less likely to lend to private enterprises. This is even more obvious in the current economic situation,as credit risks rise along with climbing levels of non-performing assets at the nation's banks. Interest rates are reflecting the rising risk premiums and banks are becoming more cautious in their lending.
Infrastructure Investment Analysis
The decline in private sector investment is a critical issue.Overcapacity has naturally made entrepreneurs cautious in committing to new and longer term projects. Many private entrepreneurs lack confidence in China's economy. When there is significant downward pressure on the economy,fiscal support from the state can be very helpful in spurring growth and bolstering confidence. State-owned banks will support the construction projects of state-owned companies as these firms respond to government calls to boost investment. But private companies do not behave in the same manner and they need further encouragement. Moreover,in the context of a lingering weakness in the renminbi,enterprises in general are trying to avoid exchange rate risks. This is bound to slow the pace of investment in China. The government needs to ensure the economy makes steady progress if it is to encourage private sector investment. One component of that scenario is to ensure a stable exchange rate while effectively managing the problems of industrial overcapacity.
This year,infrastructure investment should climb about 20% and the real estate market should show greater activity. The upturn can be seen through three key indicators - property sales as measured by area,land acquisition by area and investment values - all of which have shown a marked upturn since the beginning of this year.