No need to be pes­simistic about China's econ­omy

The Pak Banker - - OPINION - Yu Yongding

AF­TER 30 years of break­neck growth, the Chi­nese econ­omy has en­tered a new nor­mal. While ac­cept­ing the fact that China's po­ten­tial growth rate has slowed sig­nif­i­cantly, it is worth em­pha­siz­ing that 6.5 per­cent is still a high growth rate. If such a rate is main­tained, China will achieve its ob­jec­tive, set in 2010, of dou­bling per capita in­come by the end of 2020. Over the past 30 years, one of the most im­por­tant fea­tures of China's growth has been its de­pen­dence on in­vest­ment, es­pe­cially real es­tate in­vest­ment. The growth rate of in­vest­ment has been con­sis­tently higher than that of GDP. China has three main ar­eas of in­vest­ment: real es­tate, in­fra­struc­ture and man­u­fac­tur­ing. Real es­tate ac­counts for one-fourth of the to­tal in­vest­ment, and for a long pe­riod it has been the most prof­itable of the three.

At the end of 2015, the to­tal floor area of un­sold houses in China was more than 700 mil­lion square me­ters, while the av­er­age an­nual floor area of the houses sold in nor­mal times was 1.3 bil­lion sq m.

But faced with a dou­ble-digit growth in in­ven­tory, real es­tate de­vel­op­ers have greatly re­duced their in­vest­ment. In fact, the growth rate of real es­tate in­vest­ment has dropped to al­most zero, and 2016 is very likely to see real es­tate in­vest­ment growth en­ter­ing neg­a­tive ter­ri­tory. Con­sid­er­ing the large share of realty de­vel­op­ment in GDP and the links be­tween real es­tate and other sec­tors such as steel, ce­ment, plate glass, alu­minum, coal and other con­struc­tion ma­te­ri­als, one can see how large the im­pact the fall in real es­tate in­vest­ment will have on over­all eco­nomic growth.

Ideally, the govern­ment should en­cour­age more house­hold con­sump­tion to off­set the fall in real es­tate in­vest­ment, but that is eas­ier said than done. House­hold con­sump­tion is largely stim­u­lated from within, and it is un­likely to in­crease at a very fast pace while the eco­nomic growth rate is at its low­est in a decade.

No doubt the fun­da­men­tal cause of the slow­down is struc­tural. Apart from the di­min­ish­ing re­turns on scale, the mis­al­lo­ca­tion of re­sources, man­i­fested in the in­vest­ment fever in real es­tate de­vel­op­ment, is the main con­trib­u­tor to China's fall­ing po­ten­tial growth rate.

Two types of spi­rals are work­ing on the Chi­nese econ­omy. The first is the over­ca­pac­ity-de­fla­tion spiral?the fall­ing pro­ducer price in­dex be­cause of over­ca­pac­ity lead­ing to the de­clin­ing prof­itabil­ity of en­ter­prises. In re­sponse, en­ter­prises have to delever­age and re­duce in­vest­ment, which in turn leads to more over­ca­pac­ity and a fur­ther fall in the PPI, al­though this will help sta­bi­lize prices in the fu­ture.

The se­cond type is the debt-de­fla­tion spiral: the fall­ing PPI leads to ris­ing real debt, which in turn leads to the de­clin­ing prof­itabil­ity of en­ter­prises. In re­sponse, com­pa­nies have to delever­age and re­duce in­vest­ment, which in turn leads to the same re­sults as above.

Faced with the pos­si­bil­ity of a growth rate below 6.5 per­cent, the govern­ment should pro­vide a stim­u­lus pack­age to break the two spi­rals, while con­tin­u­ing to push for re­forms and eco­nomic re­struc­tur­ing. Of course, a stim­u­lus pack­age, com­pris­ing mainly in­fra­struc­ture in­vest­ment and pro­vi­sion of pub­lic goods and ser­vices, should be fi­nanced by the is­suance of govern­ment bonds rather than credit ex­pan­sion.

Al­though break­ing the debt- de­fla­tion spiral will be dif­fi­cult, China's eco­nomic fun­da­men­tals are sound thanks to its high sav­ings rate and rel­a­tively strong fis­cal po­si­tion. As long as the govern­ment can im­ple­ment a good pol­icy mix, the econ­omy will re­bound and re­turn to a slower but still in­spir­ing growth path.

Need­less to say, a stim­u­lus pack­age will only cre­ate some breath­ing space for China. The real key to sus­tain­able growth is to give en­trepreneur­ship full play. To achieve this, the govern­ment has drawn up a com­pre­hen­sive plan for re­form­ing the own­er­ship, fi­nan­cial and in­no­va­tion-sup­port sys­tems.

No one can say for sure that the above plans will fully suc­ceed, but there is no need to be too pes­simistic about China's eco­nomic prospects. China will push ahead, as it has done time and again over the past more than three decades.

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