Fixed asset investment was the most important driver of China’s growth for many years and generated almost half of all demand.
China’s economic growth seemed to have stabilised around 6.5% in line with its growth potential. According to the International Monetary Fund’s prediction, the Chinese economy will grow by 6.8% in 2018 and 6.5% in 2019. This may not be encouraging for the government, but news on other fronts is looking less sanguine.
Fixed asset investment was the most important driver of China’s growth for many years and generated almost half of all demand. Investment has recently become less important due to structural adjustments. Chinese government is finding it difficult to create sustainable aggregate demand as investment weakens and this, in turn, creates a huge challenge for policy-makers in Beijing.
In the first three quarters of 2017, fixed asset investment growth year-on-year was a low 7.8%. Investment growth has been declining since late 2013, and the decline has accelerated since the second half of 2017. China has not seen such low investment growth in decades. While the exact share of investment in GDP is unknown, fixed asset investment accounts for more than half of GDP, and capital formation accounts for 47% of GDP. Either way, it proves eminently the importance of investment as a driver for economic growth.
If such is the trend, would increase in other components of demand be able to compensate for decreased investment in 2018? In the first three quarters of 2017, the annualised growth rate of household consumption was 5.9% in real terms, demonstrating a fall of 0.5 percentage points over the previous year. To imagine a sudden surge in household consumption in 2018 will happen, and that will boost the aggregate demand, looks too far-fetched.
On the external front, China’s exports show uncertainty. Despite considerable growth recovery in the EU and US, and somewhat promising global growth prospects, no one knows what the impact will be of US President’s trade protectionism on China’s exports. China will maintain a ‘positive’ fiscal policy, but may be constrained by local government debt and clampdowns on local government financial vehicles. It will be forced to introduce tax cuts.
Can China reignite investment growth in 2018? Its fixed asset investment consists of three main categories: manufacturing, infrastructure and real estate. Although manufacturing has the largest share of total investment at 30%, it has declined since 2012. Unless China achieves a breakthrough in innovation or in institutional reforms, it is unlikely that manufacturing investment will rise significantly.
Real estate investment has shown a strong cyclical pattern over the past two decades. After a strong recovery in early 2016, it fell again in 2017. Considering the government’s determination to contain rising house prices, it is unlikely real estate investment will rebound any time soon.
The only hope is infrastructure investment. The share of infrastructural investment has been rising since 2012, and is approaching the share of manufacturing investment. Further infrastructural investment may worsen resource allocation and will be difficult to fund, considering the government’s fiscal position and stronger financial regulation.
Some foreign observers and economists believe that China is sitting on a debt bomb and they feel that the bursting of China’s credit bubble and a resulting Minsky moment are imminent. These concerns ignore the improvement to China’s financial situation since the second half of 2016.
China’s corporate debt-to-GDP ratio is falling. The leverage ratio of China’s non-financial corporations fell by 0.5 percentage point in the third quarter of 2016, and has continued falling since. In the first quarter of 2017, the debt-to-GDP ratio of China’s ‘above scale’ industrial corporations fell by 0.7 percentage points year-on-year.
China’s debt market has calmed. In 2016, there were 19 defaults involving a total of 28 billion RMB ($4.32 billion). In 2017, there have so far been nine defaults, totalling 4.8 billion RMB ($740 million). Compared with the scale of China’s corporate debt market, these figures are negligible.
Although China’s banks are fraught with many problems, their performance is among the best in the world. China should balance growth and financial risk prevention. A poor growth performance will worsen financial stability and vice-versa. In the longer run, China can benefit from government-promoted innovation as well as recent structural reforms.