This all worked fine until 2017’s deleveraging campaign targeted shadow banking, leaving the private sector short of funding. At times shadow activity accounted for more than one quarter of all financing in the economy.
Since then the government has been trying to force the banking system to support the private sector. This shift is challenging a banking industry that hasn’t had the assessment of credit risk at the core of its business.
Looking more broadly, the allocation of credit is just one part of a triumvirate of structural policy challenges facing China.
The main drivers of China’s impressive economic performance over the past two decades have been credit, exports and internal migration. All are increasingly constrained.
While the banking system’s preference for SOE funding has long been an issue, it has become increasingly pressing as the stock of credit has reached 250 per cent of GDP. China itself has acknowledged credit as a driver of growth is running out of road.
At the same time, tension around export-driven growth has become obvious. China became the world’s largest exporter of goods in 2009.
In 2016, however, China began to lose market share to cheaper destinations. Global trade frictions suggest this trend has further to run. Even the EU has strengthened its language, requesting China show “greater reciprocity and non-discrimination”.
Perhaps China’s most intractable challenge, however, is demographics. The working age population began to fall in 2014 and total population will begin to decline over the next decade. This makes China’s strategy of reallocating labour from the country to the city more challenging.
China tried to adjust this destiny by abolishing its one child policy in 2015. However the small bump in the birth rate in 2016 was not sustained, and in fact birth rates have declined further since then. Moreover, in the next 10 years the number of Chinese women aged between 23 and 30 – a key fertility cohort – will fall by 40 per cent.
In addition, China’s pension system seems inadequate for the task ahead. On one measure China’s pension assets are only 1.5 per cent of GDP. A recent report suggests that pension funds for urban employees could be exhausted by 2035.
We should be more sceptical around the pace at which China will become the world’s largest economy. World Bank data put China‘s GDP at $US12.24 trillion and the US at $US19.48 trillion. That’s a meaningful 59 per cent starting point advantage for the US.
The US is also less reliant on exports, has an increasing working age population and while its debt levels are similar to China, far less dependent on credit growth in the post-crisis period.
In this context it will be very difficult for China to become the world’s largest economy by 2030. Even reaching that milestone by 2050 seems ambitious.
For the countries that have increasingly benefitted from China as an export market, slower growth in a wealthier economy is not necessarily worse; the rise of Chinese tourism or demand for high-quality food imports in recent years is evidence of that. But China accounting for one third of global growth creates a headwind for the world.
While China is likely to continue to post solid rates of growth for quite some years, particularly given the 2020 objective to double GDP per capita from 2010 levels and thereby become a moderately prosperous society, China’s growth is more obviously converging to the global mean over time. The only question that remains is: how quickly will that occur?
Richard Yetsenga is Chief Economist at ANZ