China’s future and its ability to restructure its economy was the core of discussion at the recent Future China Global Forum held in Singapore. While there were concerns, both speakers and delegates remained confident that China can and will ride out the current challenges.
As the world’s second largest economy, China attracts global attention. The nation of 1.4 billion people is undergoing a tectonic shift as it moves from being the factory of the world to a more consumer based economy.
How quickly China re-balances its economy will have enormous impact on global financial markets and indeed the global economy. In 2014, the services share of Chinese GDP hit 48.2%, well above the combined 42.5% share of manufacturing and construction, according to a report by the World Economic Forum.
The trend is clearly moving towards the services sector. In the first half of 2015, services activity grew 8.4%, far outstripping the 6.1% growth in manufacturing and construction. Services are in many respects the infrastructure of a consumer society, creating better paying jobs and helping to underpin social progress.
China’s economic outlook and performance, therefore, are of great importance not only to the Chinese people but to the rest of the world. As Tharman Shanmugaratnam, Singapore’s deputy prime minister and Coordinating Minister for Economic and Social Policies noted at a recent conference, “We all have a vested interest in China’s continued transformation and successful transition to a market-based economy and inclusive society.”
Speaking at the recent Future China Global Forum in Singapore, he noted that China contributes a quarter of global economic growth each year despite all the challenges it faces. “China is not only about economic and financial policies. It’s about embarking on an ambitious program of social reforms such as healthcare, education and social security,” he said. “This is not merely an academic exercise.”
The country, he added, has the most complex challenge of any major economy in the world but it has a much bigger chance of success in overcoming these challenges. “It has a clear destination and a clear route. In the US and Europe, the destination is unclear and the direction of travel is also unclear.”
The deputy prime minister noted that while China is unique among the large economies it was not totally unique because it too is subject to market forces. This means that when supply exceeds demand, wages will fall and the economy will slow.
And if Chinese companies cannot repay debt from income, the value of the debt diminishes and banks will be forced to write down the debt.
Kicking the can down the road
Given the huge debt overhang, estimated at $28 trillion or 282% of the country’s GDP according to McKinsey and Co, Beijing faces a huge mountain to climb in reining in borrowings. As a result, the financial outlook for Chinese companies is deteriorating at a record rate.
“The share of rates issuers in China with negative outlook bias…has increased to a record high of 69%,” according to Moody’s as quoted by a Financial Times report in May. This proportion was up from 15.7% at the end of last year and 33.3 % at the end of March.
According to Jin Keyu, Professor of Economics at the London School of Economics, not enough is being done by the Chinese government to tackle this problem. “We need key reforms in the financial sector. Productive private entrepreneurs do not have access to capital while household share of the GDP is fading,” she told the audience of high-powered executives and policymakers. “How will that move consumption?”
Jin added that there is a tradeoff between economic growth and financial stability and Chinese policymakers should be more concerned about financial and macroeconomic management rather than achieving a certain level of growth.
Since 1978, China has undergone four major cycles of economic growth, propelled by critical reforms. In the late 1970s under Deng Xiaoping, the government relocated labor from state to private sectors, leading to the creation of 400 million jobs by the private sector.
“Right now, the major distortion in the economy is the mis-allocation of capital between the state and private sector,” Jin noted. “Financial sector reforms are therefore critical to direct capital where it is most productive and the private sector has been a major driver of growth.”
Undertaking these reforms sooner rather than later is of great importance, said the Singapore deputy prime minister. Postponing adjustments that are required in the short term often leads to problems being larger in the long term. “Allowing failing companies to stay afloat, for example, prevents a long term clear out and an over-reliance on monetary policy to right structural problems does not work,” he said.
Shanmugaratnam noted that the Chinese leadership is aware of these problems and they are being actively debated. “The most serious problem is the remarkable build-up of corporate debt but even now credit intensity of production and GDP growth continues.”
If the Chinese leadership and corporations can accept some short-term slowdown to strengthen long-term growth, there is a case for realistic optimism for China’s long-term growth, he noted. But much will depend on productivity growth in the future as the era of easy growth is over.
Achieving productivity growth will be much harder as it will rest on what happens within each company and each industry. But the opportunities for internal convergence and learning within industries are enormous. And as Kenneth Jarrett, president of the American Chamber of Commerce in Shanghai noted, China is just too important for the international community to ignore.