China is the world’s second largest economy and here we discuss some of the implications for economic growth in the country
The Chinese economy is the second-largest in the world. Its growth is hugely influential on the global economy. China is by far the biggest consumer of minerals such as coal, iron and aluminium, and its increasing demand for services and consumer goods is being driven by government policy and by the burgeoning Chinese middle-class(1). As people become better off, they pursue a higher standard of living including nicer places to live and therein lies part of a potential problem.
Chinese policymakers are keen to avoid the housing bubble that beset western democracies a decade ago and which helped to trigger the biggest financial crash since the Great Depression.
If it were just a case of curbing middle-class aspirations in China, the solution would be fairly simple; authorities would curtail the extension of loans and mortgages while also restricting excessive building projects. That would lead to a degree of restraint in both the demand for and supply of housing and other property. It would also help to keep inflation under control.
Happily, the Chinese authorities have taken precisely these measures. At the beginning of 2016, property price increases rocketed as demand was fuelled by cheap mortgages and lax controls over who qualified for them. In addition to this, local governments were able to borrow cheaply to fund ambitious but often ill-considered housing and infrastructure projects. These made the local government’s economic numbers look good in the short-term, but stacked up debt problems on top of white elephant-projects while stoking inflation.
Since then, rules have been imposed that ban using borrowed money to place a deposit on a property, while lenders are required to be more stringent in their due diligence of potential borrowers in general.
Not only has this given rise to a steady decline in the rate at which Chinese property prices have been increasing, it has also led to some of the less justifiable projects being unceremoniously halted.
A recent example of this is the Lanzhou New Area, a region about the same size as New York City(2). The local government borrowed heavily to create an urban living space complete with transport, rows of high rise buildings and “theme-park reproductions of the Parthenon and the Great Sphinx”(3).
The project began in 2012 with Beijing approval and a brand-new site being started from scratch. The ambition was to house a million residents by 2030.
That won’t happen.
The project was scotched after the Bank of Gansu Co. refused to renew the $311 million line of credit in 2017 that was funding the development. Only around 150,000 people are thought to have taken up residence.
The bank pulled the funding as it became increasingly clear that policy-makers’ patience with anything other than a rock-solid project had run out. Any remaining doubt on this point was removed when Chinese Premier Xi Jinping consolidated his power base at the Communist Party Congress in October 2017. Mr. Xi talked of a “new era” in which the Chinese economy will transition out of manufacturing and infrastructure, and into sustainable growth industries such as technology and consumer goods.
This is entirely laudable, but one has to consider the broader implications for economic growth in the country.
According to data from the National Bureau of Statistics of China, real estate and construction investment (and therefore spending) dropped from stratospheric levels between 2013 and 2016 before being propelled upwards by the availability of easy credit. With that credit being choked off, the substantial contribution by the real estate sector to the national economy is seriously curtailed.
And that leaves the national annual economic growth target of more than 6.0% under threat. This is a problem for the senior leaders in China who, over recent years, have been keen to deliver growth of between 6.0% and 7.0%.
When Chinese growth targets have been under threat in the past, there has been a tendency to do whatever it takes to maintain growth numbers in the short-term, no matter what the downside implications might be.
The worst example of this was during Chairman Mao’s infamous “Great Leap Forward” during which endless tonnes of useless steel were produced.
Times have changed though. Deng Xiaoping’s policy in the late ‘70s and early ‘80s of opening China up to foreign investment, albeit within tightly controlled strictures, put the country on an irreversible path of economic and cultural development.
President Xi’s current policy of financial control bodes well. Policymakers will need to maintain prudence over debt levels and property prices, while accepting that overall economic growth will fall as a consequence in the short-term.
The extent to which economic discipline overcomes short-term temptation will help to determine how robust China’s economic growth is likely to be. This directly affects the financing available to the new, sustainable economy that China is striving to develop. The discipline to resist propping up growth figures in the property sector will afford greater resources to the economic future of China provided by the “new” industries of technology, services and consumer goods.
At the moment, we are optimistic that China is serious about financial discipline. However, we do expect the rate of growth in China to fall in the short- to medium-term. The country is undergoing the latest instalment of a high-speed industrial, structural, financial and cultural revolution that really began to take hold in the 1980s. That’s around 200 fewer years to adapt than the UK has had for the same set of processes.
(1) According to McKinsey Global Institute, around 270m Chinese urban consumers will earn the equivalent of between $9,000 and $34,000 a year. While more than 30m more will be earning more than this. Source: ‘Mapping China’s middle class’, June 2013
(2 & 3) ‘Roadkill on China’s new route to progress’, Bloomberg 22 January 2018
Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at May 2016. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.
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