Is the Chinese economy facing a crisis?

01 September 2015


  • China’s stock markets and its real economy are two different concepts and changes of the stock markets do not reflect the true situation of the real economy
  • The Chinese economy is experiencing serious challenges, heightened by falling GDP growth and rising debt levels
  • Slower growth rate is part of the ongoing economic transformation, and even at the rate of 5% or 6%, it will still be among the highest in the world’s major economies
  • There are enough positive factors that lead us to remain cautiously optimistic about China’s future growth prospects

China’s recent stock market turmoil has caused deep worries among global investors. This is coupled with depressing figures for China’s GDP growth rate, imports and exports and consumption of automobiles and luxury goods. Many people are concerned whether the world’s second largest economy has lost its growth momentum and is heading for a hard landing. So what is really happening?

Don’t be distracted by the fluctuations of the stock market

First of all, we need to recognise that China’s stock markets and its real economy are two different concepts and therefore should be treated as such.

In comparison to equity markets elsewhere, China’s stock market plays by different rules. Policy changes have often had a greater effect on the prices than market forces. It’s more like a casino, as China’s famous economist Professor Wu Jinglian put it (echoing earlier remarks by Keynes on stock markets more generally) and doesn’t  tend to reflect the true situation of the real economy (see chart).

Another feature is that the majority of investors in China’s equity markets are individuals, instead of institutional investors as seen in London or New York. They are more vulnerable to market shocks, which have a knock on effect on their consumption behaviours.

How about the real economy?

It is true that the Chinese economy is experiencing serious challenges. In the first half of this year, China’s GDP growth only reached 7% according to official statistics (and some analysts argue the real figure should be even lower), which was the lowest level in three decades.

The current economic slowdown is a result of many factors, including sluggish world economic growth, falling imports and exports, the induced fall in demand for Chinese manufacturing, a subdued housing market and inactivity of state-owned enterprises (SOEs) due to shocks of the anti-corruption campaign, and financing difficulties for SMEs.

The most serious threat comes from the high debt levels that have built up in China since 2009 due to high investment levels, particularly in property. Total debt is now estimated at around 280% of Chinese GDP, higher than that for Germany (250%) and lower than that for Greece (320%) and Italy (335%). Where such debt-fuelled property bubbles have burst in the past, this has often led to more or less severe recessions, for example in the UK, Sweden and Canada in the early 1990s, Japan through most of the 1990s and the US, Spain and Ireland after 2007.

Local government debts, accumulated through their own investment platforms, reached RMB 10.9 trillion by June 2013, according to the National Audit Office. A big chunk was spent on luxurious government offices and landmark squares, or other low return investment projects. It’s a big challenge for the central government to reign that in and find a solution for those non-performing loans.  

Having said that, the lower GDP growth is in line with targets set by the Chinese leadership who have recognised the inherent structural problems with the old pattern of “growth above all” and vowed to rebalance the economy, making it more sustainable and environmental-friendly so to avoid falling into the “middle income trap”. In the Chinese context, it is called the “new normal”.

The painstaking transformation – shifting from investment- and export-driven growth to a more domestic consumption focused one – is much in line with the recommendations of international economic pundits. Yet its implications, due to the size of the Chinese economy, have been strongly felt by countries and companies who are closely linked to China’s strong growth, in particular the commodities sector.

In this early stage, nobody knows if, or when, China would succeed in this strenuous shift, given the difficulties and uncertainties. But there are enough positive factors that lead us to remain cautiously optimistic about China’s future growth prospects. The following drivers will help keep the economy going, at least for the next few years:

  • Investment, a key propeller of China’s rapid rise, rose by 11.2% in the first seven months, maintained its growth momentum, though at a slower rate. The One Belt One Road initiative is believed to spur trillions of new investment in infrastructure projects while help “export out” China’s industrial overcapacity and revitalise trade and investment links between Asia and Europe.
  • Domestic consumption, rising over 10% in the same period, remains robust, contributing to 60% of China’s GDP. China’s “population surplus” still hasn’t reached its end and will add 16 million new labour forces to the market each year. Lower oil prices will also help reduce cost and prop up consumption.
  • Imports and exports, another key growth pillar over the past decades, suffered heavily, falling by 6.9% in the first seven months due to sluggish global demand, rising costs and economic slowdown. But exports remain strong and could benefit from the RMB devaluation. While China will need to do more to deal with the new challenges and to improve its terms of trade, its status as the world’s largest trading nation will not collapse overnight, and will continue to attribute to future GDP growth.
  • Urbanisation is still at an early stage and will bring 300 million new migrants to the cities by 2020, generating huge demand for housing, infrastructure and other supporting industries at an estimated market value of nearly RMB 1 trillion.
  • Industrial production slowed to 6.3% year on year in the first seven months, but there was strong growth in high value goods such as telecoms, pharmaceuticals, high-speed train, robotics and aeronautics. The Made in China 2025 initiative, which calls for increasing China’s innovation capability, quality efficiency, integration of industrialisation and information technology, and green development, is believed to spur new investment in the identified 10 priority industries*, and generate new business opportunities for both foreign and Chinese companies.
  • Technological advances will contribute further to economic growth by generating new business activities. China already has 700 million smart phone users and over 600 million Internet users, together with the world’s largest online payment market. Cloud computing hardware and services were up by 40% in 2014 and is expected to retain its growth momentum. Further, China’s commitments to environmental protection and climate change remain intact, creating massive infrastructure spending and new business opportunities along the way.
  • Government restructuring is likely to streamline the approval process, making doing business easier. Reform of state-owned enterprises will create more business opportunities for the private sector. The government initiative of “encouraging people to do business creatively and drive innovation” is likely to spur new investment and employment opportunities.

Putting these factors together, China’s economy is likely to continue growing at a reasonable rate over the next few years. Even at the rate of 5% or 6%, it will still be among the highest in the world’s major economies.

And size matters. China is already the world’s largest economy in purchasing power parity terms and according to a recent PwC report, despite the fact its growth rate may slow down to 3-4% in the long run, China is also projected to overtake the US in around 2028 in market exchange rate terms.  

Overall, notwithstanding recent events, China’s economy is expected to continue to grow, albeit at a slower rate and businesses will need to adjust to this “new normal” when developing their own growth strategies.

 Allan Zhang is a Senior Asian Economist and Director of PwC Consulting in London.

Allan Zhang | Director, Sustainability & Climate Change
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