Chinese dilemma as growth accelerates
Sustaining growth versus deflating credit
by Danae Kyriakopoulou in London
Tue 23 Jan 2018
Last week's news that China's economy had expanded by 6.9% over 2017, exceeding the leadership's target of 6.5%, must be met with caution. These figures rest on shaky premises, following a year in which several provincial governments admitted to having faked statistics that artificially inflated growth estimates for 2014-16.
The implications of fake statistics extend beyond Beijing. As the world's second-largest economy, China's performance has global influence. Inflated Chinese figures created the illusion that the world economy, too, was performing robustly. The plateauing of carbon emissions during what was thought to be a period of increasing economic activity was celebrated as improvements in efficiency. In hindsight, the slowdown in the northern provinces of China's rustbelt is a more convincing explanation. In 2017, global carbon emissions rose again.
This, alongside unofficial Chinese indicators, suggests the recovery may be real this time. But even if 2017's growth statistics are correct, it will be difficult to sustain the pace. China's economy is maturing, and slowing growth is natural. It is also welcome. Last year's performance was supported by strong exports on the back of a recovering global economy, and by government spending on infrastructure. In Q4 2017 infrastructure was 22% of China's total fixed investment, a record high. In absolute terms the figure stood at £2.2tn, substantial even for China's size as the world's second-largest economy. This is because of the traditionally skewed nature of the country's economy towards fixed investment, which contributed 43% to China's GDP in 2016, compared with 23% for Japan and 20% for the US.
This is exactly the structure China wants to move away from, albeit gradually. The leadership's priority is not – and should not be – the pace of growth, but its composition. This involves rebalancing away from exports and manufacturing towards consumption and services, and up the production chain towards value-added activities. Last year China joined Japan, South Korea and Germany to become one of the top five US patent recipients. Chinese inventors received more than 11,000 patents, a tenfold increase from 2008 and a 28% increase from 2016. This compares with just 6.4% annual growth in patents awarded to US inventors, who still hold first place. Investment in technology is a priority. While domestic regulations still censor Google search, the company announced last month that it will be opening an artificial intelligence research centre in Beijing.
Despite such signs of progress in economic development, there are concerns about financial stability. Rapid credit expansion has been a significant driver of China's impressive growth. In its December assessment, the International Monetary Fund noted that 'credit growth has outpaced GDP growth, leading to a large credit overhang. The credit-to-GDP ratio is now about 25% above the long-term trend, very high by international standards, and consistent with a high probability of financial distress.' While corporate debt stands at 165% of GDP, political pressure to maintain high growth has created disincentives to let struggling state-owned enterprises fail.
Credit rating agencies Moody's and S&P cited financial stability concerns when downgrading China's sovereign credit rating last year. Even so, the renminbi has strengthened. Last week Andreas Dombret, a member of the Bundesbank executive board, announced that Germany's central bank had decided to include renminbi in its currency reserves. This followed the decision of the European Central Bank last year to include renminbi in its reserves. The Banque de France subsequently revealed that it also holds some currency reserves in renminbi, without providing any details. This has boosted the renminbi for now. But deleveraging will play an important role in determining the renminbi's reserve currency status in the longer term, as well as China's broader economic future.
In 2017 accelerating growth was accompanied by a falling debt-to-GDP ratio for the first time since 2011. But the balancing act between sustaining growth and deflating credit levels is becoming more difficult.
Danae Kyriakopoulou is Chief Economist and Head of Research at OMFIF.
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