China can’t rely on investment for its economy
Amedia report claiming China’s fixed- asset investments will exceed 45 trillion yuan ($ 6.5 trillion) this year has recently gone viral. Some observers are placing the expected 45 trillion yuan in investments on par with the 4 trillion yuan stimulus package from 2008. The stimulus plan quickly put China’s economy on its fast track amid the global financial crisis but created some unwanted side effects including industrial overcapacity, rising inflation and hikes in asset prices.
To be fair, even if fixed- asset investments surpass 45 trillion yuan this year, it is by no means an astronomical figure. The country’s fixed- asset investments rose to 59.6 trillion yuan in 2016, up 8.1 percent from the 56.16 trillion yuan in the previous year. If fixed- asset investments grow at a similar pace, they could hit 64 trillion yuan this year.
The reason why the latest media report raised eyebrows is that people are concerned that China’s economy may retreat to an old growth path of relying on stimulus. And such worry is not unfounded.
The downward pressure on the economy still persists. Private investment continues to slow, property investment – which contributed a lot to the GDP growth in 2016 – is expected to cool down and consumption may not grow as quickly as anticipated given that the tax incentive on small- engine car purchases, a key factor that drove up car sales last year, has been reduced this year. All these factors indicate that the pressure on stabilizing the economy will be huge and will add to pressure on the government to increase the investment to offset these challenges. In addition, the local leadership transition in 2017 may create fresh investment demands as some local governments may be tempted to increase fixed- asset investments that will bolster the economy to impress higher authorities.
Excessive reliance on stimulus is a syndrome. Once a country is addicted to stimulus, it will refuse to accept natural economic corrections and show zero tolerance for economic decline.
Over the past year, China was torn between pushing ahead with supplyside reforms and relying on investment and the property sector to boost its GDP. Without doubt the supply- side reform is still China’s economic lifeline that will foster a sustainable growth path and ensure the country can overcome the middle income trap. It is a battle that China cannot afford to lose and requires patience and political willpower to carry it through.
China will face a lot of challenges in 2017. Compared with 2008 when loose monetary policy and excessive credits were the main policy instruments, this year we will see a neutral monetary policy. That means a tight monetary condition will not support massive investment. The situation will likely give rise to shadow banking activities. The central bank has drafted new rules to curb risks from shadow banking as signs of rising off- balance sheet credit have emerged. Off- balance sheet wealth management products issued by Chinese banks reached 26 trillion yuan by the end of 2016, up 30 percent from a year earlier, according to the central bank. Rising off- balance sheet lending will create high leverage in the financial system and lead to build- up of systemic risk. Meanwhile, debts will pile up. According to UBS, China’s debt- to- GDP ratio rose to 277 percent at the end of 2016, up from 254 percent a year ago. A mounting debt burden and high leverage will lead to an increase in bad loans.
Additionally, China has entered a new normal of consumption growth and needs to cater to a more
personalized and diversified consumer demand. The rise of overseas purchasing agents and cross- border e- commerce indicates that domestic supply cannot meet the demand for qualified products. Addressing the mismatch between supply and demand is key to upgrading the country’s consumption model and the success of that transition to a more sustainable growth model.
Externally, China faces uncertainties given the rise in trade protectionism and complicated geopolitical changes.
Every time China’s economy faces downward pressure, it is a test on the policymakers’ resolve and commitment to economic reforms and restructuring. To instill investors’ confidence and ensure long- term sustainable growth, it is time for local governments to break away from the old way of relying on investment and property sector to fan the economy.