BOFIT Viikkokatsaus / BOFIT Weekly 2019/12

China’s economic growth, which witnessed a slowdown last year, continues to slow this year. While uncertainties that include the current trade war with the United States, domestic indebtedness and unreliable statistical data make it hard to judge China’s true economic circumstances, our latest BOFIT Forecast for China 2019-2021 nevertheless sees an ongoing slowdown in annual GDP growth towards around 4 % by the end of the forecast period.

The drag on Chinese economic growth comes largely from structural factors. The population is ageing rapidly. The working-age population (15–64 years) has been shrinking since 2014, and the absolute number of people in the workforce declined last year for the first time in the modern era. The dependency ratio continues to deteriorate at a rapid pace. The structural evolution towards a services-driven economy also limits opportunities for productivity gains. It is difficult to boost investment growth much as the investment rate is already the highest among all large economies. The need to address China’s environmental problems also depresses the country’s growth outlook.

China has stubbornly clung to the political goal of doubling real 2010 GDP by 2020. The need to constantly apply stimulus to reach the growth targets has caused the country’s indebtedness to soar. Moreover, statistics have been falsified in order to meet targets increasing uncertainty and complicating decision making at all levels.

Room to manoeuvre in economic policy is limited. As long as the fiscal policy stance remains extremely accommodative, the sustainability of local government indebtedness is highly problematic. In the corporate sector, further debt-driven stimulus is also difficult to justify in the face of rising defaults and bankruptcies. Moreover, debt financing beyond a certain point has diminishing returns as new borrowing goes to paying off old debt. Any increase in stimulus measures exacerbates the likelihood of sudden economic decline.

The government’s focus on supporting economic growth has pushed needed structural reforms to the back burner, but the trade war brought them back to the fore. However, measures to consolidate the party’s power and increase control over society conflict with economic reforms.

The likelihood of a sudden slump in economic growth has increased. In countries that have gone rapidly into debt like China, it is common to see the episode end with a sharp drop in GDP and a crisis in the financial sector. The current astronomical apartment prices relative to incomes poses a clear risk. A correction in housing prices would not just cause problems for households but for heavily indebted companies in the construction sector as well. In the banking sector, small and mid-sized banks are most vulnerable. Even if the trade war is resolved amicably, the US and China will continue to compete for global dominance, which will stoke trade and geopolitical tensions also in the coming years.