Global investors likely to remain optimistic about China, despite growing friction with the US and expectations of significantly slower growth over the coming decade
This article includes brief commentary on China’s growth over the previous decade, likely average growth rate over the coming decade, key points to keep in mind while assessing the Chinese economy and its outlook, state of the Chinese economy and Real GDP forecasts (2020 - 2022).
China’s growth over the previous decade
During the period 2010-2019, China grew at an average rate of 7.7% and baring 2017 growth decelerated continually during the aforesaid period. Further, post-2011, there was a marked downward shift in growth which is evident from the graph below. China’s growth averaged 7.1% between 2012-2019 and by 2019 growth had decelerated to 6.1% (which is 4.5% lower than 2010 growth rate of 10.6% - a massive economic stimulus fueled growth in 2010).
For a perspective, it might be pertinent to mention here that during the same period (2012-2019), the US economy’s average growth rate was 2.34%. In essence, despite the Chinese economy slowing down during the aforesaid period, it grew at three times the rate at which the US economy expanded.
China - Real GDP Growth (2009 - 2019)
Source: theglobaleconomy.com
Average growth rate could fall below 5% over the coming decade
Having stated the above, China is likely to grow at a significantly slower (yet sustainable) pace over the next decade when compared to the previous 10 years. The average growth rate over the next decade could fall below 5% (compared to 7.7% between 2010 - 2019), as China seeks to shift to more sustainable growth that is oriented towards domestic consumption, from an unsustainable growth path that is heavily reliant on investments and exports.
Other factors such as the possibility of partial decoupling of the US and Chinese economies, increasing contentiousness with reference to trade and technology issues between the two countries, lower capital accumulation, worsening demographics and limited productivity gains when compared to previous decades, overhang of debt hovering over the Chinese economy - particularly non-financial corporate debt (159.1% of GDP - Q1 2020, according to IIF data) - and slow reform process in several areas (for example, reforming the state owned enterprises) are also likely to have significant downside implications for China’s economic growth over the coming decade.
Next, less trade and cross-border investment between the US and China is likely to have a greater downside impact on the Chinese economy, compared to the US, over the coming years.
Having stated the above, the Chinese economy has significant potential, if structural reforms are undertaken in earnest over the coming decade and it is able to harness its gargantuan consumer base, focus on high-quality development and industrial restructuring, and is able to successfully deleverage while generating growth.
China will have to tackle its mountain of debt with prudent macroeconomic policies and productivity-enhancing structural reforms, if it is to fully realize its economic potential.
Two developments pertaining to the Chinese economy are noteworthy and should be tracked: first, China has liberalized its financial sector, which should be of significant interest to US-based financial services firms; second, inbound foreign direct investment continues to remain strong, as China steps up efforts to attract foreign businesses. These developments seem to suggest that global investors are apparently optimistic about China, notwithstanding its increasingly contentious relationship with the US.
It is essential that China deepens its financial markets, while opening the same, as this will help it to escape the middle-income trap.
Key points to keep in mind
While making any assessment of the Chinese economy and its outlook, its important to note that exports account for around 20% of China’s GDP. Its top five export destinations are the US, EU, Hong Kong, Japan and South Korea. Together, they account for around 55% of China’s exports. Further, China has been over-investing for years and its credit fueled investment splurge has been taking a toll on growth in recent years. Moreover, the return on investment has fallen markedly which has serious downside implications for growth. It might be noted that capital investment as a percentage (%) of GDP in China is around 43%.
State of the Chinese economy
As is evident from the graph, the Chinese economy expanded by 3.2% y/y in Q2 2020, after contracting by 6.8% y/y in Q1 2020. Prior to this, growth had been slowing down over 2019.
China - Real GDP Growth (Y/Y, 2019Q1 - 2020Q2)
Source: theglobaleconomy.com
Briefly, China’s economic recovery this year is investment led, with state owned enterprises driving it rather than corporate investment. Real estate and infrastructure investment have been the main drivers of this investment-led growth. However, worryingly consumption spending has fallen.
This is an important imbalance to take into account while assessing China’s economic outlook, as consumption was the primary driver of its economic growth for six consecutive years and contributed, according to official sources, 57.8% to growth in 2019.
We at Virtuoso Economics expect the Chinese economy to grow modestly y/y by 2.3% in 2020, which is significantly lower than the previous year (6.1%). However, China is the only major economy that will record growth this year.
Having stated the above and looking beyond some of the latest high frequency data (such as PMI’s, fixed investments, exports etc.), the recent economic upturn (which is broadening) does not seem to be a harbinger or precursor of a robust economic recovery. There are indeed significant challenges ahead.
For example, global economic recovery remains fragile. The economic health of China’s five leading export destinations (the US, EU, Hong Kong, Japan and South Korea) gives rise to concerns and there is considerable uncertainty about their future growth trajectory.
Private consumption in China continues to languish (it is likely to contract this year on an annual basis) and seems to be the weakest link in the economy. Credit growth is likely to exacerbate financial stresses over the coming quarters and there is strong possibility of further escalation of US-Chinese trade and technology related frictions over the coming months.
Having stated the above, fiscal and monetary policy is likely to underpin economic recovery in Q3 and Q4 2020 and the investment outlook seems more favorable now.
Chinese Economy - Real GDP Forecast (2020 - 2022)
Finally, once economic recovery is well entrenched, we expect macroeconomic policy in China to shift focus from macroeconomic stabilization to containment of financial risks and leverage.
Disclaimer: This article is for informational and non-commercial purposes only and should not be used as professional or investment related advice.
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