## China’s Bumpy Path

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### Overview and recent performance
- China’s GDP measured at market exchange rates was $18.3 trillion in 2022.
- That is 73 percent of the GDP of the United States and 10 times more than the 7 percent of US GDP it registered in 1990.
- China’s per capita income is roughly $13,000, approximately 17 percent of US per capita income—compared with less than 2 percent in 1990.
- Over the past decade and a half, China accounted for 35 percent of global nominal GDP growth, while the United States accounted for 27 percent.
- The article highlights that China achieved this without many attributes economists consider crucial for growth (a well-functioning financial system, strong institutional framework, market-oriented economy, democratic/open government).

### Sources of growth and rebalancing
- Historical pattern:
  - Growth has relied largely on investment growth financed by an inefficient banking system, a pattern that intensified after the global financial crisis of 2008.
  - Increased investment accounted for about two-thirds of GDP growth during 2009–10.
- Structural characteristics:
  - China is labor-rich with a capital-to-labor ratio much lower than advanced economies; more investment can be desirable in principle.
  - Much investment has been driven by the public (state) sector rather than the nongovernmental sector; state-owned enterprises receive a disproportionate share of bank credit and typically have not generated strong returns.
- Rebalancing objectives set by the government:
  - Reducing reliance on investment-heavy growth and getting household consumption to be the key contributor to GDP growth.
  - Generating more growth from the services sector than from low-skill, low-wage manufacturing.
  - Shifting away from physical-capital-intensive growth in a manner that improves employment growth.
- Recent progress:
  - Household consumption has become the main contributor to growth.
  - The services sector now accounts for more than half of annual GDP and close to half of aggregate employment.
  - The trajectory toward rebalancing has been uneven but showing significant progress.

### Growth prospects and determinants
- Labor force dynamics:
  - China’s labor force (population aged 15–64) is shrinking; by 2030, it is expected to decline by about 1 percent a year.
- Investment trends:
  - Recent decline in non-governmental investment growth; state investment accounted for much of the growth in overall fixed asset investment outside the property sector in 2022.
- Productivity:
  - Over past decades China averaged 3 percent growth in total factor productivity.
  - Productivity growth has slowed to about 1 percent a year over the past decade.
  - The article emphasizes that China’s growth will run aground without an improvement in productivity growth.
- Dual circulation policy and constraints:
  - The government’s “dual circulation” policy seeks greater reliance on domestic demand, technological self-sufficiency, and homegrown innovation alongside continued global engagement.
  - Constraints include continued need for foreign technology, rising geopolitical rifts that could limit access to foreign technology and markets, and a recent government crackdown on private firms in sectors such as technology, education, and health that has chilled entrepreneurship.

### Potential pitfalls and debt vulnerabilities
- Aggregate and sectoral debt:
  - Over time debt has risen relative to the size of the economy—though gross debt levels are said to be not out of line with those of other major economies such as the United States and Japan.
  - Public borrowing as a percentage of nominal GDP is lower in China than in other major economies.
  - China has a high level of corporate debt—about 131 percent of GDP.
- Currency and ownership of debt:
  - Most corporate debt is denominated in China’s own currency and owned by domestic banks and investors.
- Real estate sector concentration and household exposure:
  - Real estate investment has become a bulwark of the economy and a key source of local government revenue via land sales.
  - Household debt surged from about 30 percent of GDP a decade ago to more than 60 percent.
  - Property has become a mainstay of Chinese household wealth; households are exposed to house price fluctuations in multiple ways.
  - Total household debt is still less than total household deposits in the banking system.
- Corporate and financial sector stress:
  - Tumbling house prices have caused major developers (exampled in the text) to run into financial trouble; many developers and some financial institutions are exposed with high debt and vulnerable balance sheets.
  - Most major Chinese banks are under state control and can provide infusions of cash to troubled corporations, which reduces the risk of a systemic meltdown but may postpone underlying problems.
- Net assessment:
  - Because debt accumulation has been financed mostly by domestic savings and the state owns many key creditors and debtors, the article judges that a financial shock is unlikely to precipitate a financial crisis or collapse in growth; the more pertinent issues are major inefficiencies and waste from a broken capital allocation system.

### External risks and capital flows
- External debt:
  - China’s external debt is estimated to be 16 percent of GDP, and less than half of it is denominated in foreign currencies.
- Capital flight and exchange rate risks:
  - Economic and political uncertainty raises concerns about capital flight and a potential currency crash, but the article views this as unlikely given state ownership of much of the banking system and the government’s ability to back deposits and choke off conduits for large capital outflows.
- Reforms mismatch:
  - Reforms in recent years have been concentrated in the financial sector and capital markets, with fewer reforms in areas such as state enterprises and the institutional framework—this lack of balance creates risks.

### Financial sector reform, markets, and governance
- Needed reforms:
  - Recognize and remove bad loans from banks’ balance sheets.
  - Reform state enterprises, including reducing their dependence on bank credit.
  - Increase transparency in policy-making, improve corporate governance and accounting standards, and grant more operational independence to the central bank and regulatory authorities.
- Market interventions and volatility:
  - The government’s “schizophrenic” on-off approach—balancing maintaining confidence with allowing markets to discipline themselves—has sometimes heightened market turbulence and investor uncertainty.
  - Opacity in corporate governance and accounting has contributed to large fluctuations in stock and bond markets because investors lack reliable information.

### Policy dilemmas and outlook
- Key policy dilemmas the government faces:
  - How to continue reducing debt while maintaining growth.
  - How to reduce energy-intensive production while the economy relies on heavy industry.
  - How to get markets to exert financial discipline even as the government strengthens state control.
  - How to restrain wealth inequality while relying on the private sector to generate more wealth.
  - How to encourage private sector innovation while cutting successful private enterprises down to size.
- Historical coping and costs:
  - The government has repeatedly managed severe stresses and averted banking crises, massive currency devaluation, housing market meltdown, and economic collapse.
  - Each near miss has exacted a toll, including a huge buildup in domestic debt, loss of $1 trillion in foreign exchange reserves during 2015–16, and highly volatile asset prices.
- Scenarios for the future:
  - The article argues that economic and financial collapse is not inevitable.
  - Unfavorable demographics, high debt levels, and an inefficient financial system will constrain China’s growth.
  - If the government “plays its cards right,” a more benign future is possible—moderate growth that is more sustainable economically, socially, and environmentally.
- Overarching tension:
  - Reconciling the government’s contradictory impulses—more freedom for markets while maintaining heavy-handed intervention to preserve “stability and order”—poses difficult challenges and may generate short-run uncertainty that undermines support for needed reforms.

*Source: China’s Bumpy Path, December 2023 (F&D).*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2023/december/54-58-prasad-final.pdf_