Talking Point

Big, bigger, better?

What to expect from the Chinese economy in 2015

A worker operates at a construction site on the 68th storey of a building in Shenyang

High base effect: the world’s biggest economy can’t keep growing at a breakneck pace

“The world’s most important economy” is the descriptor used by the Financial Times when it refers to the US these days. That may seem a little subjective, but the newspaper clearly wants to avoid describing America as the ‘world’s largest economy’. That’s because official data showed that – on a purchasing power parity basis – China’s economy surpassed America’s in size in the second half of last year.

The FT reported at the weekend that in 2014 the American economy had grown at its fastest pace in a decade. By contrast the performance of the world’s biggest economy was getting fewer celebratory headlines. The consensus is that GDP growth has been slowing in China.

In fact, the FT’s Asia editor David Pilling even speculated this week that India could topple China as the world’s fastest growing economy as soon as next year. The World Bank reckons it will happen in 2017 (when China grows at 6.9% and India at 7%).

Owing to its size, China’s growth rate is of more than passing interest to businesspeople around the globe – which means all eyes are on the figure for 2014 and the government’s GDP target for this year.

But of equal importance is the sustainability of that growth rate and the economic reforms that will be required to deliver it. So when Premier Li Keqiang travelled to Guangdong last week his trip was loaded with symbolism. Talking up the case for reform, Li was consciously drawing parallels with the earlier ‘Southern Tour’ of Deng Xiaoping, in which the then paramount leader signalled his preference for a market-based approach.

So amid the continuing talk of a slowdown, the debate is broadening into a discussion of the new economic direction that China is going to take.

How is GDP growth looking?

The official numbers are due for release later this month. But growth slowed notably to 7.2% in the final quarter of last year, according to the predictions of 31 economists polled by Reuters, marking the weakest performance since 2009, when China was contending with the collateral damage of the global financial crisis. In a similar survey for the full year Bloomberg estimated that growth is going to top out at 7.4%, which would mean that policymakers have just missed the annualised goal anticipated by most analysts.

Qu Hongbin, HSBC’s Chief China Economist, says its best not to obsess about the final number. “Whatever GDP growth in 2014 turns out to be, it won’t be far away from the government’s 7.5% target,” he told the South China Morning Post.

He also believes that it’s not worth speculating much on the specifics of this year’s growth goals either, as a single number is unlikely to be given.

Instead, expect an indicative range, most likely between 7% and 7.5%. “The main reason is probably to make it an easier target to hit or even exceed,” Qu explains. “So 7% will probably be taken more as the bottom line.”

How will the goals be met?

Premier Li Keqiang is calling for a revitalised effort to maintain growth “within a proper range”, as China wrestles with the challenges of an economic “new normal”.

His agenda is said to include a stepping back from stimulus as a means for juicing up growth; a determination to slash debt in the financial sector; and a readiness to oversee structural change, even at the expense of short-term pain.

Li trumpeted the same message during his three-day tour of Guangdong province last week, where he left flowers at a statue of Deng Xiaoping in Shenzhen, revering the man who led China’s opening up over 35 years ago.

He then met a group of former officials who accompanied Deng during his own landmark trip to the city in 1992, and encouraged Shenzhen to continue exploring ways to push reform “bravely”, and not to be afraid of making mistakes.

Then again, media reports that the government is pushing ahead with investment across at least 420 infrastructure projects valued at Rmb7 trillion ($1.1 trillion) this year seem to jar with Li’s focus on a less interventionist style of economic management.

Spending at that level would dwarf the Rmb4 trillion stimulus of 2008, for instance, implying that Beijing is going back to basics by pump-priming the economy for the year ahead.

The NDRC, China’s top state planning agency, has been accelerating project approvals since last summer with total spending increasing by 21% year-on-year to Rmb10 trillion by November.

This struggle between medium term ambitions for fiscal discipline and the more immediate imperatives of keeping the economy growing at a high rate is something we’ve remarked upon before, most recently in WiC233.

Perhaps mindful of the parallels with earlier efforts, spokespeople at the NDRC have refused to confirm the full estimates for their latest investment plans. More pertinently, they say the programme bears little resemblance to the past, with a new focus on revitalising the economy by restructuring it, rather than stimulating it with a cavalcade of cash.

Hence the focus on seven key areas for investment (including infrastructure, environment and healthcare), which aims to dispel suggestions of an across-the-board handout, as well as the renewed emphasis on wooing private capital rather than relying purely on public funds.

“It’s not a stimulus programme by expanding fiscal input. It’s about guiding social capital into investment projects,” Luo Guosan, a deputy director of NDRC, told the domestic media. “It has nothing to do with the Rmb4 trillion stimulus plan in 2008, and it is fundamentally different from that.”

A new approach is needed?

One factor in favour of a new direction is that China can no longer rely on parts of the economy that used to supercharge its growth. A good example is the role of the property industry as a bulwark.

Earlier this month Shenzhen Special Zone Daily exemplified the sector’s contribution with a story about the visit of another political heavyweight to Shenzhen, Zhu Rongji, then China’s Premier, in 1997. During a roundtable discussion Zhu clashed with Wang Shi from property firm Vanke, after Wang wondered aloud whether real estate could really become the energising force that Zhu hoped.

Zhu shot back that property had to take on the responsibility because the other options for stimulating growth were limited.

“What if we abolish the hukou system?” he asked his audience in a stage-managed style, before answering his query with a “No, we cannot”.

“What if we open up the financial markets,” he continued.

“No, we cannot,” Zhu rhetorically countered again.

“And what if we open up consumer credit”?

“No, we can’t,” he insisted. “At least, not within the next two years.”

With these options exhausted, real estate would have to take on the task itself, Zhu claimed. “I must promote the property sector to become a pillar industry within two years,” he told his audience.

Since then the property business has contributed an ever-increasing share of gross domestic product: at least 15% – and much more if the knock-on effects on other industries are considered.

More recently real estate has been acting as a drag on the wider economy, with sales contracting by about 10% and falling prices biting into homeowner and investor confidence. Investment in the sector to November slowed to 11.9% from 19.5% in 2013, for instance, and the slowdown is draining the financial resources of local governments, which rely on revenue from land sales for about a third of their income. Proceeds fell sharply for much of the year although the impact is only going to start showing up in the coming months, analysts warn, because of the two-quarter time lag between auctions and the final payments.

So where is the momentum going to come from?

The long-term goal is that China’s consumers will start spending more, unleashing a new era of growth. But although retail sales have been growing at more than 10% a year, this isn’t enough to herald the deeper transition to a more consumer-driven economy. Sales were also slowing in the final quarter of 2014 as consumer confidence dipped.

Optimists hope that shoppers will feel a little richer as the fall in oil prices feeds through into lower energy and heating bills. Businesses might benefit from the prolonged slump in global commodity prices, delivering cheaper goods to shops and supermarkets (producer prices fell about 3% in December from a year earlier, the 34th monthly drop in a row).

But others see the price declines as a mixed blessing, reflecting chronic overcapacity in many industries, as well as weaker demand for their final goods. The gnawing fear is that deflation becomes self-fulfilling as lower prices crimp profits and reduce the incentives for companies to invest, while consumers hold back on larger purchases in the hope that prices will drop further.

This year will witness the lowest salary growth for at least a decade, says McKinsey, the consultancy, and this promises to be a shock for a workforce that has grown accustomed to double-digit increases. It comes at a time also in which the chances of making a killing in property are waning too, the report notes.

The impact of this slowing wealth generation could be dramatic because few of China’s better earners were members of its ‘middle class’ the last time that there was a significant downturn.

“They could well overreact to a small slowdown and turn it into a larger one as a result,” McKinsey warns.

Will the reform agenda deliver an economic dividend?

One approach to buoying spending is encouraging people to save a little less. Here we can expect more media coverage of pilot plans to reform the household registration system (the much hated hukou that Zhu referred to in his dialogue with Vanke’s Wang). This will allow better access to city schools and hospitals for millions of migrant workers currently barred from benefiting from municipal services.

That might also prompt millions of new consumers to commit more confidently to spending, as well as spurring the further population transfers from rural regions (the upshot: earlier returns on China’s massive investment in urban infrastructure).

Another item on the agenda is mixed ownership reform – i.e. bringing the private sector into state-dominated industries (see WiC230). That could lead to spin-offs of parts of the state’s largest commercial empires, as already seen with Sinopec’s fuel distribution business (see WiC251).

A third strategy is to foster the advance of China’s tech sector. That’s already happening as companies like Alibaba and Tencent start to shake up industries once dominated by staid state giants, including telecoms and banking.

In Shenzhen last week Li Keqiang visited WeBank, China’s first internet bank, which is co-owned by Tencent. “We will lower costs for and deliver practical benefits to small clients, while forcing traditional financial institutions to accelerate reforms,” the prime minister promised at the opening ceremony. “It’s one small step for WeBank, one giant step for financial reform,” he added (paraphrasing the words that were first used when Neil Armstrong landed on the moon – which suggests to us he views financial reform as a pretty major challenge).

This week Tencent and JD.com (Alibaba’s nearest e-commerce rival) also served notice that they are targeting the auto sector with a major investment in Bitauto, a provider of online marketing and e-commerce services for carmakers.

This kind of activity is making the bosses of the internet firms the new darlings of government officials, says Feng Lun, the chairman of Vantone, a large developer. Feng noted at a forum in Hainan last month that the tech titans are stealing the limelight from longtime participants at the top table, like the property bosses. “In the past, the internet-based new economy was the ‘concubine’ of local governments, and we [the developers] were their ‘wife’,” he quipped. “But now the seats have changed, and they [the internet companies] have replaced us. The only face-saving thing is that we are allowed to sit at a nearby table and watch them eat.”

Of course, policymakers want to see the internet transforming more traditional industries, as its influence spreads to companies, creating new efficiencies and benefits. Focusing on the ‘building blocks’ of the digital economy is a must, McKinsey suggests, with cloud computing, wireless communications, big data analytics and online sales platforms all expected to deliver a productivity boost.

This will help the thousands of smaller, privately-held enterprises that struggle to reach China’s fragmented marketplaces or lack the resources to compete with their better-financed but more wasteful state-owned peers. But bigger firms should also benefit. If just six sectors (automotive, consumer electronics, chemicals, real estate, financial services and healthcare) tap more directly into the tech boom they could deliver as much as Rmb1.2 trillion of new GDP each year, McKinsey believes. New analytics are going to improve inventory management and sales forecasting; innovative distribution platforms will bring down sales and marketing costs; and online collaboration will prompt breakthroughs in innovation and design (for early signs of the power of Xiaomi’s ‘ecosystem’, see WiC247).

Across the Chinese economy as a whole the pay-off could be even greater, reaching Rmb14 trillion of gains a year by 2025. A third of this upside stems from the creation of new markets, McKinsey’s report concludes, with the remainder coming from companies doing things more efficiently than they do today.

Are near-term worries about a slowdown overdone?

Markets are jittery these days, in part because of worries about the global impact of slowing growth in China. But if fears of this type have become the conventional wisdom, not everyone shares the pessimistic outlook. For example, the influential creator of the BRICS concept, Jim O’Neill, estimates that even at a slower growth rate, China is going to add more to the world economy this year than the US, when measuring their respective outputs on a purchasing power parity basis.

Indeed, while the market has become fixated with the percentage rate of Chinese growth, it’s helpful to look at China’s absolute GDP increases too.

Hence if we assume the economy grew 7.4% last year (versus 7.7% in 2013) that would equate to Rmb4.35 trillion of added GDP. Okay, that was less than the Rmb4.94 trillion that the economy added in 2013, but it still works out marginally above the mean for the previous decade, which was Rmb4.33 trillion.

By that calculation 2014 was, in Chinese economic terms, an average year. And if the economy grows at just 7% this coming year – adding another Rmb4.41 trillion – it looks like being another fairly average year again…


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