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China’s GDP increased by 6.8% year-on-year in the first half of 2018 and we expect GDP to grow by 6.3-6.7% in 2018 and 6-6.6% in 2019. However, after 2020, GDP growth is expected to decline to an annual rate of 5-6% in 2021-2025, though ongoing economic rebalancing should sustain higher annual consumption growth of 5.8-6.8%. Consumption accounted for 78.5% of GDP growth in the first half of 2018, compared to 31.4% for investment. This strong consumption growth is supported by a record-high consumer confidence.
Fixed urban assets investment growth declined to 5.5% year on year in the first seven months of 2018. The slowdown in investment is mainly driven by the government’s deleveraging campaign, reducing funding for local government infrastructure and State-Owned Enterprises (SOEs) investment projects.
2018 forecast change
2019 forecast change
|Real GDP Growth||6.9||6.5||6.3||6.0||5.3||0.0||0.0|
|1-Year Lending Rate||4.4||4.4||4.4||4.5||4.7||0.1||0.0|
Recent government policy statements and measures indicate that the deleveraging campaign has slowed down and may even be temporarily reversed, due to concerns about the slowdown in investment and negative impact of a trade war. The central government is now encouraging local governments to speed up spending of unused revenues and banks to ensure adequate financing for local government projects. This contrasts with earlier policies aimed at discouraging excessive lending to local government. The deceleration in shadow banking credit growth is also likely to reverse in the second half of 2018.
In July 2018, the central bank injected CNY502 billion into the Chinese banking system using 1-year loans. The Chinese government also announced CNY1.2 trillion in business tax cuts in addition to infrastructure spending measures, due to higher external “uncertainty”.
The 2008 financial crisis’ impact on the Chinese economy was smoothed out by a large fiscal and credit stimulus programme, though growth still slowed down gradually. The cost of the stimulus was an excessive rise in debt and investment levels. Debt has started to stabilise relative to GDP, and we expect the Chinese economy to continue on a path of soft deceleration. However, risks of a more abrupt debt restructuring or a hard landing remain.
Higher investment boosted labour productivity. This was partly offset by the lower return on capital of the new investment projects and higher investment spending also contributed to the massive rise in China’s debt levels. Scaling back of the government stimulus and the start of a rebalancing towards consumption led to a drop of three percentage points in investment to GDP by 2018. China still invests 44% of its GDP despite economic rebalancing, significantly above the global average. The consumption to GDP ratio declined by 11 percentage points in 2001-2010, reaching a low of 36% in 2010.
The early part of the decline of consumption to GDP in 2001-2007 reflects a boom in private sector investment and employment, which required a large rise in private sector saving due to China’s restrictive financial system. Despite the recent rebalancing of the economy, China’s consumption to GDP ratio has increased slowly, reaching 38% in 2017 (compared to a world average of 56% and an emerging markets average of 51.5%).
Domestic aggregate demand was not enough to fully absorb the rising savings of Chinese households and firms, leading to a rise in the current account balance that peaked at 10% of GDP in 2007. The growing need to finance investment and liberalisation of financial markets, together with rebalancing towards consumption led to a decline in the current account to GDP ratio since 2007, reaching 1.3% in 2017.
The credit and fiscal stimulus programmes led to ballooning non-financial sector debt levels, rising from 142% of GDP in 2008 to 256% of GDP in 2017. Leverage started stabilising in 2016. Corporate debt to GDP started falling in 2016 but this was compensated by rising government and household debt. Year-on-year lending growth in the first half of 2018 remained high at 12.8%. However, this masks a change in composition with a greater proportion of lending to more profitable private sector firms and a decline in the share of lending to local governments and SOEs. The reallocation of lending towards more efficient private sector firms should ultimately allow China’s financial system to sustain similar growth rates with less reliance on credit.
While China’s debt levels are likely to remain extremely high by emerging markets standards over the next five years, any banking crisis is likely to be contained, causing a major downturn but avoiding a hard landing. Most of China’s debt is between state-owned banks and state-owned borrowers (e.g. SOEs, local governments). Resolution of non-performing loans or defaults is much easier to coordinate and less costly than in financial systems that are focused on private financial institutions and borrowers (e.g. in the US).
Short-term hard landing risks are mainly of a moderate credit crunch combined with a disorderly economic rebalancing process (e.g. excessively fast liquidation of unprofitable SOEs with slower than expected increases in private sector employment). A conventional financial crisis is more likely to emerge over a 10-year period, if the current high debt levels are maintained while China continues to liberalise its financial system to become much more private sector focused.
The rise in non-bank financing has raised financial risks, but it still accounts for a moderate part of total credit, and the government’s recent deleveraging campaign has significantly reduced the share of non-bank financing in total credit. The growth rate of some of the riskier types of non-bank financing has declined substantially. Shadow banking assets have declined from 87% of GDP at the end of 2016 to 73% of GDP in June 2018, according to estimates by Moody’s.
Household debt levels have recently increased above the average for emerging markets. However, household debt levels are still quite low at 48% of income, and the tightening of mortgage down payment conditions since 2016 should contain excessive growth in mortgage debt. Credit card debt and other types of consumer borrowing levels are still moderate, albeit growing fast.