China picking up, but new slowdown looms

In my view China’s growth, properly measured, has slowed from rates that genuinely were 10% pa or more for two decades up to 2010, down to perhaps 3-5% in 2018. Heavy stimulus over the last 9 months, both fiscal and monetary, is bringing a patch pick up currently, with less 'oomph' than in past stimulus periods. In part this reflects the increasingly sluggish response of the economy to yet more debt and yet more infrastructure of doubtful use. But it also reflects the impact of the trade war with the US. Still, the government will do more if necessary and it likely will be enough to give China another 12 months of decent growth. But the economy will slow again in 2020-21 and reviving it will be a lot harder. The most likely outcome is a prolonged period of much slower growth in the 2020s, perhaps 2-4% properly measured.

Over-investment is the key problem

While exports were an important driver of growth in the early 2000s, investment has been the dominant force since 2009. Fast-growing Asian countries like Japan and Korea in their ‘miracle’ years saw a ratio of investment to GDP of about 30%. China’s ratio reached 45% in recent years reflecting both massive over-investment and considerable inefficiency. The ratio has been falling in recent years, which has brought slower growth, but it remains very high. The private sector in particular has become reluctant to invest while real estate, a huge driver of investment both directly in houses and in the industrial base necessary to support it (steel, glass, cement etc), is on increasingly precarious foundations as the number of empty flats continues to rise.

Rising debt

Since about 2010 this high rate of investment to keep growth going has been achieved only with a substantial rise in debt ratios in the corporate sector and also in local governments. Meanwhile government debt, fully accounted, has moved up to about 70% of GDP and the total government deficit, including local government investment vehicles, has risen to over 10% of GDP according to the IMF. In addition, to keep the housing sector growing the government has encouraged a build-up of mortgage debt which now stands at an estimated 90% of household incomes.

Stimulus is getting harder

A further rise in debt ratios would be imprudent, but might also be difficult to achieve as caution is likely to set in. The most likely outcome of this over-investment and over-indebtedness is a long period of slow growth for China in the 2020s. Credit has gone in cycles as the government has attempted to slow the debt build-up then relented as the economy slowed too much and the recent new surge in credit should enable GDP to pick up this year. But the new slowdown beginning in 2020 will be difficult to fight. The danger is that this turns into a hard landing, due to financial stresses. Much of the debt is owed by state enterprises to state banks, so probably the system will just seize up rather than fracture. The consequences for the rest of the world of a slow China will be considered in a subsequent post.