No need to be pessimistic about China's economy
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.