BOFIT Viikkokatsaus / BOFIT Weekly 2019/40

Growth of over 6 % p.a. is required for China to meet its declared goal of doubling 2010 real GDP by 2020. Like before, our latest BOFIT Forecast for China, however, expects growth to fall faster than official projections perhaps to around 4 % p.a. at the end of the forecast period in 2021.

Unreliable official figures that fail to capture economic trends make it more challenging than ever to get an accurate picture of China’s economic situation, let alone to produce solid forecasts. Official figures report an extremely modest drop in growth, but a review of a broad range of economic indicators and anecdotal evidence suggest that the current economic situation is clearly worse than in early 2018.

Domestic factors are largely the cause of the economic slowdown, and structural factors alone already pose a significant drag on the economy. Escalation of trade tensions has made matters worse. Several institutions (including the Bank of Finland, IMF and OECD) estimate that the tariff increases reduce China’s growth by about one percentage point a year if 25 % additional customs tariffs are applied to all trade between the US and China. As the causes of the trade war are deeply rooted in China’s current system, we expect tensions to continue. Their resolution requires China to address system-level issues.

Productivity-enhancing reforms would be essential to sustaining growth potential, but major reforms have been postponed years. Capital allocation is increasingly inefficient as an ever-larger share of financing goes to low- or negative-profitability state-owned enterprises and role of the Party in the economy surges. The concentration of power in the hands of a party leadership reluctant to move ahead with reforms increases the danger of economic policy missteps.

China has increased fiscal stimulus to support growth, even as the room for stimulus has become more limited. The actual public-sector deficit is rising rapidly. The IMF estimates that general government debt is approaching 80 % of GDP. If the current policy to support unsustainable pace of growth continues, it will distinctly erode government finances during the forecast period.

As growth is sustained by debt-fuelled stimulus, China’s debt ratio has soared to a disturbing level of around 260 % of GDP. Banking crises are often associated with countries that experience such rapid increases in their debt-to-GDP ratios. Corporate access to financing has become tighter, which, in combination with the slowdown in domestic growth, has severely reduced outward FDI flows of Chinese firms.

The relentless pursuit of economic stability through stimulus in the current, still relatively benign, economic conditions diminishes economic buffers and further delays the implementation of reforms crucial to locking in long-term growth. This, along with the weakening of corporate finances and increased financial market risk, heighten the danger of a serious recession.