BOFIT Forecast for China

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1 BOFIT Forecast for China 27 March 2018 BOFIT China Team BOFIT Forecast for China Bank of Finland BOFIT Institute for Economies in Transition

2 Bank of Finland BOFIT Institute for Economies in Transition PO Box 160 FI Helsinki Phone: bofit@bof.fi BOFIT Forecast for China BOFIT China Team 27 March 2018 Updates and disclaimers This site is subject to constant update and revision. While the Bank of Finland attempts to assure the correctness and timeliness of all material posted on the site, it takes no responsibility for errors or omissions which are the result of technical causes, or otherwise. Further, the Bank of Finland specifically disclaims all responsibility for damage or harm caused as a result of use of information provided herein. The Bank of Finland maintains the right to delete or modify in part or in full any information on this site without prior notice. Material available on our website may be borrowed freely, as long as the source is mentioned. Links to the Bank's website may also be established from your own site. However, it is to be remembered that responsibility for whether or not a link is current lies with the creator of that link.

3 BOFIT China Team BOFIT Forecast for China The pace of China s economic growth accelerated slightly last year, with official figures showing GDP growth of 6.9 % p.a. Even if the economic cycle appears on the upswing, growth is undergirded by the government s heavy-handed stimulus policies. Since the Communist Party s National Congress last autumn, the policy stance has tightened and the role of the party has been amplified. As a result, we have slightly boosted our GDP forecast for this year, putting it on par with China s official GDP growth target of about 6.5 %. Going forward, high growth fuelled by debt will become unsustainable. China s debt-to-gdp ratio is already high and will continue to rise in the forecast period. Thus, we expect growth to slow to a more sustainable level of around 5 % by Several sources of uncertainty from both domestic and international markets cloud China s economic outlook. Downside risks have increased from our previous forecast. Official figures show economic growth in China accelerated slightly last year to 6.9 %. While it is difficult to distinguish business cycles from the smooth GDP growth figures, it appears that economic conditions have improved compared to on the recovery in external demand and steady growth in domestic consumption. High growth was also supported, however, by the government s stimulus policies designed to maintain favourable economic conditions ahead of the convening of the 19 th National Congress of the Communist Party of China (CPC) last October, where the policy framework for the next five years was set forth. Last year s market trends were underscored by the party s growing obsession with stability. Major economic reforms have not been carried out as previously expected and some reforms even reversed. Concrete reform execution plans were notably missing from the addresses made at the National Congress, and instead policy has shifted exclusively to meeting the goal of doubling China s real 2010 GDP by With this shift in policy emphasis, we have slightly raised our forecast for 2018 from the previous BOFIT forecast. The GDP-doubling target calls for growth this year of about 6.5 %, which Chinese officials are expected to achieve through debt-financed stimulus. In coming years, dealing with financial market risks and China s massive pollution problems are inevitable. Together with structural factors, we expect growth to slow to around 5.5 % in 2019 and around 5 % in Our forecast thus expects China s official GDP-doubling target to slip slightly. Due to statistical problems and officials pressed to deliver growth numbers in line with published targets, China s growth figures should be viewed with considerable scepticism. Emphasis on the party alters the policy stance The change in China s policy stance may cause changes in economic trends. The state and the party have assumed ever-greater roles since the change in rhetoric at the National Congress last October. The adopted package of constitutional amendments at the National People's Congress (NPC) in March, further strengthened the CPC s grip on power and blurred the line between party and state. One of the most notable amendments was the elimination Bank of Finland / Institute for Economies in Transition 1 BOFIT Forecast for China 1/2018

4 of the presidential term of office. It allows the party to further consolidate power with president Xi Jinping. The authoritarian policy shift may slow China s market-based reforms and its opening up to the world. Our outlook for a gradual slowing of growth over the longer run remains unchanged, however, as China continues to develop and the structural change in the economy proceeds. The slowdown in growth is a natural result from structural features such as an ageing population and a shift to a services-based economy. President Xi and premier Li were re-elected for a second five-year term at March s NPC gathering and several new political appointments were made. During the current forecast period, what may matter most is how the new party leadership deals with needed economic reforms that have been put on hold in recent years but are nevertheless essential to realising China s growth potential. These include reforms of state-owned enterprises and the public sector, reforms in taxation, pensions and the hukou household registration system, as well as opening up of the economy and improving the environment for doing business. China s growth is based to an increasing extent on growth in consumption that is supported by strong income growth. While 60 % of economic growth last year came from consumption, there is still room for additional growth. Private consumption accounts for just 39 % of GDP and public consumption 15 % of GDP. While growth in fixed investment has slowed, its share of GDP remains very high (44 %). In coming years, increasing public consumption through e.g. education and healthcare is important in sustaining consumption growth, and will require more efficient allocation of public funds. Fixed investment growth should slow for the most part due to the above-mentioned structural factors and the already high levels of local government indebtedness that reduces the amount of funds available for additional investment. China s economy was also buoyed last year by a recovery in external demand. The volume of goods exports grew by about 7 %, while import volumes grew even faster, increasing by almost 10 %. We expect imports to continue to rise faster than exports, as China s consumer markets continue to grow much faster than the global average. Services deficit, which has been driven by an explosion in Chinese tourism abroad, reduces the current account surplus. Last year s current account surplus was just over 1 % of GDP. Conflicted economic policy targets Given China s advancing level of development, a strict adherence to numeric GDP targets distorts the dimensioning of economic policy. Nevertheless, China s leaders continue to embrace the goal of doubling real GDP by 2020 a target that requires annual GDP growth above 6 % over the next three years. Pursuit of this object leads ineluctably to a worsening of an already bad debt situation and increased fragility of the financial system. Numerical growth targets are problematic also in that they reduce the credibility of official statistics. New cases of statistical fraud at the provincial and local levels have come to light this year, and have again reinforced scepticism about the reliability of China's national statistics. Notably, reining in indebtedness, mitigation of financial market risk and reducing pollution were highlighted as economic policy targets at the end of last year. High growth targets directly conflict with these goals. Reaching them would require quickly winding down heavily indebted state enterprises and polluting industries, thereby reducing economic growth over the short run. China s total debt-to-gdp ratio (excluding the financial sector) now stands at around 260 %. Corporate debt has reached roughly 165 % of GDP. An unreasonably large proportion of corporate borrowing goes to funding unprofitable or low productivity state-connected enterprises and to servicing existing debts. Investment profitability has also decreased. Bank of Finland / Institute for Economies in Transition 2 BOFIT Forecast for China 1/2018

5 While corporate acquisition of debt slowed a bit last year, households picked up the slack and are currently piling on debt at a blistering pace. Much of this reflects soaring housing prices. Certain actions to control the financial risks, especially restrictions on shadow banking sector lending, tighter supervision of financial markets and harmonisation of supervision measures have been carried out in recent months. These measures are still inadequate to actually reduce financial market risk or bring down the level of indebtedness. The increased emphasis on stability has led to increased restrictions on capital movements, as well as greater government controls of housing and financial markets. China continued to tighten restrictions on capital outflows last year, essentially bringing net capital outflows to a halt and boosting the yuan s exchange rate. The yuan appreciated 7 % against the US dollar last year, weakened 6 % against the euro and remained essentially unchanged against a trade-weighted basket of major currencies. Although the yuan s exchange rate has been let to fluctuate freer than earlier, officials still scrupulously monitor the exchange rate movements and are ready to quickly intervene. China frequently reiterates its commitment to liberalisation of exchange rates and promoting international use of the yuan. Yet the recent measures, if anything, contradict these goals. Moreover, capital outflow controls have reduced foreign direct investment outflows, and China has tightened its outward FDI guidelines. Projects that fit under the Silk Road umbrella, however, continue to get support and enjoy access to cheap financing. Inflation has remained modest, with consumer prices on average running well below the 3 % inflation target ceiling. US-educated Yi Gang was named the People s Bank of China s new governor in March. He is expected to continue the policies of his predecessor Zhou Xiaochuan. If so, the PBoC s role in opening up the economy and as a pioneer in market reforms will hopefully continue. The PBoC faces non-trivial monetary policy challenges in the forecast period. It must maintain an accommodative monetary stance to support economic growth in an environment where global interest rates are expected to rise, while reducing indebtedness and controlling the rising financial market risks. Risk of hard economic landing continues to grow China s medium-term outlook is somewhat darker than in previous years. There is an increased threat of a serious financial market disruption that could lead to a rapid slowdown in economic growth, caused by the ever-higher debt levels. This risk will only grow in our forecast as pursuit of high-growth policies this year will inevitably increase levels of indebtedness. Indeed, we are already seeing companies struggling to pay their bills and minor financial market disturbances. Tightening of the credit spigot is likely to expose a great number of troubled firms and exotic financial arrangements. The firmer political grip may also have profound economic implications. China has increased domestic surveillance and monitoring of private individuals and the internet, and party organs have insinuated themselves to an increasing extent into private and foreign firms. The newly approved package of constitutional amendments included the creation of a new National Supervisory Commission for domestic monitoring and anti-corruption efforts. The increase in anti-corruption inspections are feared to degrade the business operating environment in China. The concentration of political power in the hands of a few increases the likelihood of errors in planning and implementation of policy. Contrary to our earlier expectations, China has chosen to ignore many necessary reforms. While systemic changes always carry a risk of hampering growth over the short run, failure to implement reforms degrades future growth potential and exposes the economy to larger corrections. Bank of Finland / Institute for Economies in Transition 3 BOFIT Forecast for China 1/2018

6 External risks have also increased from our previous forecast. There are increasing fears of rise in global protectionism and that the current targeting of specific product groups in trade disputes could escalate into an all-out trade war. Such circumstances would significantly worsen China s growth outlook. Moreover, the recent elevation of geopolitical tensions in China s neighbourhood could foreshadow a major conflict. Currently, the magnitude of a negative shock to the Chinese economy created by aggravation of e.g. the North Korea situation is hard to estimate. China s realised GDP growth and BOFIT forecast Sources: China National Bureau of Statistics and BOFIT. Bank of Finland / Institute for Economies in Transition 4 BOFIT Forecast for China 1/2018

BOFIT Forecast for China

BOFIT Forecast for China BOFIT Forecast for China 2017 2019 Bank of Finland BOFIT Institute for Economies in Transition Bank of Finland BOFIT Institute for Economies in Transition PO Box 160 FI-00101 Helsinki