Economy, Finance and Trade China: Heightened Capital Flight is a Key Risk China Faces

Euromonitor International’s China Economy, Finance and Trade Country Briefing, focuses on the world’s largest economy (in purchasing power parity terms) which is currently facing major internal as well as external risks. Despite continued economic deceleration, China has been successful in rebalancing toward services and consumption led economic growth. Nonetheless, the country continues to face downside risks arising from a continued depreciation of the yuan. This could heighten capital outflows and hamper its stock market, which was one of the worst performing globally in 2016. Additionally, risks stemming from potential shifts to trade and investment policies in the USA could further hamper China’s growth prospects; thereby triggering a potential China hard landing.

Overcapacity in most of its industries, recovering oil prices, rising wages and a shrinking workforce are other major concerns:

• China’s annual real GDP growth decelerated for the third consecutive year to reach 6.7% (lowest in 26 years) in 2016. This can be attributed to subdued external demand, overcapacity in most of its industries and efforts to shift the country’s economic focus from exports and investment towards domestic consumption and services. However, private final consumption levels continued to grow at a healthy pace of 7.3% in 2016;
• China is highly dependent on mineral fuels imports for its energy requirements and has benefited from subdued oil prices in recent years. The mineral products imports bill stood at US$283 billion in 2016, which was the highest in the world, thanks to its huge population, leaving the country vulnerable to risks such as supply disruptions and steady recovery in global oil prices since early 2016;
• China is blessed with the largest population in the world, making its internal market strong. Furthermore, tax incentives and less restrictive trade activities offered by China’s free trade zones (FTZs) have also greatly benefitted businesses in the country. In August 2016, the government approved the setting up of seven more FTZs in Chongqing, Zhejiang, Hubei, Henan, Sichuan, Shaanxi, and Liaoning. However, rising labour costs are causing multinational companies to shift manufacturing investments to lower-wage economies like Vietnam;
• In October 2015, China abolished its one-child policy, however, its working-age population started to decline from 2016. Additionally, China’s old-age dependency ratio will increase from 14.1% in 2016 to 25.9% in 2030, indicating a rapidly ageing populace. The proportion of those aged 65+ within the total population is expected to rise to 17.0% in 2030 from 10.4% in 2016, indicating an increasing strain on public finances in the future.

A volatile yuan and sluggish economic growth could heighten capital flight from China

Owing to the sluggish economic growth and a strengthening US dollar, the yuan depreciated against the US dollar by 6.7% (year-on-year) in 2016, its biggest collapse since 1994. This has caused foreign investors to remain jittery and start withdrawing their investments from the Chinese economy, seeking better profit elsewhere. Furthermore, continued interest rate hikes in the USA will make dollar investments more profitable, triggering higher amounts of capital outflows from China, causing the country’s foreign exchange reserve to further deteriorate. In order to control the foreseen avalanche of capital outflows, the government levied new capital controls on overseas investment in December 2016. Although this has partially helped calm a faltering yuan, the restrictions imposed over yuan flows will hurt China’s goals of expanding its global influence and intensifying the yuan’s trade internationally. Furthermore, the Federal Reserve is likely to increase interest rates at a faster pace in 2017. This coupled with Trump’s plans of imposing tariffs of 45.0% on Chinese imports could stir up a trade war, causing the yuan to plummet further; thereby worsening the situation.