China is officially entering a new phase in economic development, with growth slowing. Our local expert explains why it's actually good for the world's second largest economy to take a breather and focus on structural reform.
At the opening the annual National People's Congress on 5 March, Chinese Premier Li Keqiang announced the country forecasts a 7% rise in gross domestic product (GDP) this year. China's economy expanded 7.4% in 2014, which - although just 0.1% below its growth target - is the lowest since 1990.
According to Mr. Li, China has entered the next stage of economic development, being termed the "New Normal". Slower growth will become the norm, as opposed to the 10% average GDP growth that the country sustained for more than two decades.
The IMF seems to share the same view as it recently trimmed its projection on China's GDP growth to 6.8%.
Part of the reason for a lower growth projection is that China has already developed into a US$10tn economy and so has a bigger base to grow from. To put things into perspective, a 7% lift in the country's GDP is equivalent to the size of the entire Swiss economy (ranked the 20th largest economy in the world in 2013).
Economic outlook in 2015
The Chinese government is planning to spend 10.6% more in 2015 than they did last year, with extra money going into national defence, infrastructure projects and agriculture modernisation. The expenditure will be US$2.76tn on the back of US$2.5tn in total revenue. As a result, this year's fiscal deficit is expected to rise 0.2% to 2.3% or US$0.26tn.This will be China's largest deficit since its massive economic stimulus plan was released during the global financial crisis.
The country has also lowered its inflation forecast to 3% due to falling commodity prices. The urban unemployment rate in China is expected to be maintained at 4.5% as 10 million new jobs will be added to the economy.
Soft landing or hard landing
China's economy is taking a breather, and that is actually a good thing. It releases the economic giant from the pressure of chasing growth targets and allows it to expedite its structural reform. Indeed, for any developing economy, a slowdown is inevitable after a long period of rapid growth.
For 30 years, China experienced breakneck economic development with no historical precedent. Now, only an economic transformation could ensure sustainable growth and a "soft landing" for the economy. A "hard landing" (less than 5% growth) would bring mass unemployment and serious social implication.
Pressing challenges ahead
In the Chinese Premier's state-of-the-nation address, he pointed out some of the challenges the country is facing: stalled investment growth, overcapacity of industries, a deflation risk and rising local government debt. It indicates that China is at the crossroads of national development. The investment in infrastructure and industry that transformed its economy in the past three decades is no longer as effective in generating growth today.
China's current investment-driven growth is showing diminishing returns. It needs to re-balance its current export-led and investment-centred economy towards a more consumption-driven one. The economy could be revived by boosting domestic consumption and achieving productivity gains to replace external demand.
The demographic dividend (ie cheap labour) that propelled China's 30 years of economic boom is also depleting due to an ageing population, shrinking workforce and rising wages. China has to move up the value chain by emphasising innovation and entrepreneurship. It has to stimulate growth through the service sectors, value added industries and high technology manufacturing.
Slower growth, but still robust
China's growth is slowing down but it is not slow in relation to other major economies. The country's exports rose more than 48% and a trade surplus of US$60.6 billion was recorded in February thanks to a strengthening US economy and falling oil prices. In the first month of 2015, foreign direct investment (FDI) inflow to the country surged 29.4% to US$13.92bn.
This is the sharpest increase in FDI for the country in four years with a big portion of it pouring into the services and high-end manufacturing sectors. It indicates that foreign investors are starting to recognise China's potential in the high-value-added industries – those activities that generate a large margin. According to a report by the United Nations Conference on Trade and Development, China attracted US$128bn worth of investment in 2014 and took over the US position as the number one FDI destination in the world.
In short, China's economy remains under-developed with enormous growth potential to grow. It is estimated that a successful reform will bring China a potential GDP growth of 6% until 2020. The economy will grow another US$2trn with additional trillions of FDI and around US$700bn in outbound investment. Unlocking China's potential requires a structural overhaul in how the country manages its economy to embrace the free market. Whichever path China decides to take, it will have a profound impact not only on its people but also on the rest of world.
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