China's economic rebalancing act: What to look out for in 2017

After years of booming economic growth, it was thought by some up until recently that China was not subject to the normal rules of economic and financial gravity and that the country's growth would go on forever. However, after the financial crisis many came to realize that China's economic growth was heavily reliant on government debt-fueled investment and if that trend continued a serious 1990s Japan-esque economic collapse could be on the cards. Chinese authorities decided that growth needed to slow down and a lower "new normal" for growth has been targeted. And so it has begun in recent years. China's economic growth has steadily come back down to earth, as Chinese authorities have begun an economc rebalancing toward a more sustainable consumption-based economy.

We sat down with our Head of Economic Research and China Senior Economist Ricard Torné so he could give us an update on China's economic rebalancing and outlook for the 2017 and beyond.

What are China’s biggest economic challenges this year?

China’s main economic challenges for this year continue to be the implementation of economic reforms and tackling macroeconomic imbalances, while keeping growth broadly stable. The main downside risks to China’s economic outlook are a sharp correction in the property market and rising protectionist trade policies. Our Consensus Forecast sees GDP expanding 6.5% in 2017 before decelerating to 6.2% growth in 2018.

What reforms are China likely to undertake in the near future?

According to announcements made at this year’s National People’s Congress, the government will focus this year on reducing overcapacity in certain sectors, improving the corporate governance of State-Owned Enterprises (SOE) and encouraging mixed ownership of these, particularly in the electricity, oil, natural gas and railway sectors. Tackling the property market, the government will adopt a two-speed approach of encouraging home purchases in tier 3 and 4 cities, while boosting land supply and keeping some restrictions in cities that have experienced a strong rise in prices.

In order to contain rising leverage and financial risks, authorities are adopting a slight tightening bias for monetary policy. That said, the government is providing stimulus via a more accommodative fiscal policy to ensure that growth remains strong. While authorities will likely tighten regulation on shadow banking, their approach will be gradual in order not to squeeze credit growth.

Is China's current growth model sustainable, in your opinion? Why?

China’s traditional economic model was not sustainable as it relied heavily on cheap credit, massive investments and a fluctuant external sector. The old system generated large macroeconomic imbalances and constrained private consumption. However, the country is now moving towards a new model based on services and domestic consumption that should eventually be more sustainable.

As the Chinese government controls the financial system, why wouldn’t they continue increasing the ratio of debt to gross domestic product to keep growth going strong?

In order to keep the old economic model afloat, authorities needed to inject substantial funds to generate growth, and they did so in large part by boosting state-owned companies’ debt. The Chinese government’s tight grip on the financial sector meant it could choose repeatedly to divert money to companies—a pattern which would have been unsustainable in most other economies.

Although China may be more capable of continuing down this path to achieve higher rates of growth, authorities are aware of the problematic nature of the situation in the long run. They unveiled new regulations last year, such as a debt-to equity swap programme, to reduce excessive corporate debt.

Has China reached a point where it can open up capital flows to help with its economic rebalancing?

China has started opening up its capital account in recent years but there is still a long way to go. Increasing competition in the financial sector, allowing market forces to have a more decisive role in capital allocation and permitting even greater exchange rate flexibility are key to ensuring a successful opening up of the capital account.

China decided that its massive trade surplus was no longer sustainable and consequently increased investment recently. Are there any future consequences of this down the road?

Growth heavily fuelled by investment alone is not sustainable in the long term, just as growth fueled overwhelmingly by trade was not either. China needs to focus on achieving more broad-based and sustainable growth by boosting private consumption and services, in line with the government’s aims for its new growth model, though this will take time to materialize.

Chinese authorities will continue to support the economy via investment if the economy requires any help to maintain stable growth. Therefore, the current pattern is expected to remain in place in the coming years.

If China doesn’t grow by its target of 6.5%, what could happen? Could there be social unrest?

In order to preserve social stability, the authorities intend to keep unemployment low and ensure that citizens continue to reap some of the benefits of China’s stellar growth. They will not allow a massive economic downturn, which would have the potential to trigger social unrest and threaten the dominance of the Chinese Communist Party. If the risk of a serious downturn arose, they would intervene in the economy or slow down the transition to the new growth model in an attempt to avoid it.

Read our latest economic outlook for China or you can download a sample of our FocusEconomics Consensus Forecast for China by click on the link below.

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Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Date: May 16, 2017

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