core sector communique

ECONOMIC HEALTH CHECK

Global Downturn Contributes to China Slowdown

IMF Survey online

July 24, 2012

• Chinese growth set to moderate to around 8 percent this year
• Authorities successfully engineering a slowdown in the housing sector
• China needs to smooth transition from investment to consumption-led growth

C

hina’s growth rate is set to moderate to around 8 percent this year due to measures by the authorities to cool the economy, and the global slowdown, say IMF economists in their latest assessment of the world’s second-largest economy.

In an interview with IMF Survey online—the IMF’s online magazine—the head of the IMF China team, Markus Rodlauer, says with the right policies, and global collaboration, he is confident that China can meet its immense challenges.

IMF Survey online: The IMF recently downgraded its outlook for the global economy. What do you see as the implications of this for the Chinese economy?

Rodlauer: China’s economy has now been slowing for six consecutive quarters. This started early last year when the government deliberately put in place policies to slow the economy, which had been growing very fast. Now, on top of that, has come the global slowdown—mainly related to the euro crisis—that has slowed down the economy more than expected and somewhat more than the authorities had themselves probably intended. So, earlier this year, they switched gears and started to moderately support the economy to ensure a soft landing.

So, we are seeing growth in China slowing down, as I have said, but we don’t see it slowing down too much. GDP growth in the second quarter of 2012 came in at 7.6 percent, which was slightly better than expected. On current trends, we expect growth of around 8 percent this year which, of course, is still formidable compared with other countries in the world.

IMF Survey online: Many economies would very happy to be boasting a growth rate of 8 percent. Is this good news for China? Is it too high? Too low?

Rodlauer: We believe that growth at around 7–8 percent a year is sustainable for China and is very doable. It is also what the government set itself as a goal in its own Five-Year Plan, which was put in place last year. That being said, in order to achieve that pace of growth over the medium term for many more years, China will have to change its growth model. Over the past few years, growth in China has relied very much on high and rising rates of investment. So, investment has been very strong, capacity has been built, infrastructure has been added, but it cannot continue at this rapid pace forever. Instead, over the next few years, there needs to be a smooth handover from investment to domestic consumption as the main source of growth in China.

IMF Survey online: When you say that there needs to be a smooth handover from investment to domestic consumption, what sort of things are you thinking about? Are you talking about people spending more money on domestic items? What are we talking about for the ordinary Chinese person?

Rodlauer: Savings in China are extremely high compared to international levels. Generally, in most developing and developed countries one tends to spend about 70 to 80 percent of income and then you save 20–30 percent. You either put it aside for a rainy day or invest into future productive capacity. China, on the other hand, saves over 50 percent of its income, which means there is room to consume more.

So, what would one consume? First of all, we see that, in particular, low-income earners in China still have a way to go before they can easily afford ordinary consumer goods—such as durables like washing machines, or electronics, or services like travel or insurance. They save a lot partly because they feel that they are not so well provided for in their old age since the pension system is not very strong and the health system may not provide for the emergencies they might face. So that is why a very high proportion of their income is saved, and then either invested or put abroad into savings.

Also, corporate savings in China are very high, and there is room to distribute some of these savings either to the budget (through higher dividends of state-owned enterprises) and salaries.

So that too has to change. Savings should come down, and people need to spend more on goods for everyday life: consumer goods, furnishing their homes, but also maybe on better health care and other services like travel and insurance. It’s domestic consumption that really will need to provide more of an engine of demand in China going forward.

IMF Survey online: You made reference to housing. That was something that was a great worry a few quarters ago because of fears that there was a housing bubble in China. What’s your assessment now?

Rodlauer: Here, in particular, the government has put on the brakes quite strongly. It saw that housing prices were rising very fast, construction of new housing was almost going through the roof. And that has consequences for the financial sector—with fears of a bubble—and the instabilities this creates.

But, equally important, in China they saw that this had a profound distributional impact, that many people—because of the very rapid rise of housing prices—were starting to be priced out of the market. That is a big concern for the government. So they set themselves the goal of slowing down this boom and slowing down the rising real estate and housing prices—in fact, engineering a decline in prices. And they seem to have been successful here as we have seen a slowdown of the boom in the housing market.

IMF Survey online: The reason why so many people are interested in the Chinese economy is because the performance of the world’s second–largest economy has a huge impact on the region and on the rest of the world. China is a great consumer of commodity goods. With it slowing, what’s going to be the impact on the price of such goods?

Rodlauer: We have studied this as part of our team’s analytical work over the past year: what’s the impact of Chinese investment in general and Chinese housing investment in particular on the global economy? What are the spillovers to the rest of the world?

China has now become so large that whatever happens in Chinese investment is profoundly important, as you said, for commodity exporters, but also for goods producers, like, for example, Germany. We find that a very sharp slowdown in investment in China would have a fairly significant impact on growth and exports of goods from countries like Japan, Germany, Chile, and of course other countries in Asia.

IMF Survey online: Have you put a number on this?

Rodlauer: Yes, we have estimated that in our study. There are three groups of countries: one group includes the neighbors surrounding China. These countries are strongly integrated in what we call the “Chinese supply chain.” That is, the goods that are made in a chain of production with various countries contributing inputs, and that are then assembled in China and exported somewhere else. Taiwan, Province of China is a very clear example, Korea, Thailand, Malaysia and the Philippines are others.

For these countries, the impact is most profound and we have estimated that, for example, for Taiwan—which is the most impacted—if investment in China were to fall by 1 percentage point, growth in Taiwan would fall by .9 percent. So it’s almost a direct one-to-one impact.

Then we have a second group of countries—the commodity exporters—which are heavily dependent on demand from China. When demand in China drops, commodity prices and commodity exports from those countries drop. So, for example, for countries like Chile, which produces a lot of commodities that go to Asia, a 1 percentage point decline in China would translate into a fall of about .4 percent in Chile. And similarly for African commodities exporters, like Zambia, there is a slightly smaller impact, but in the same ballpark, .3-.4 percent.

Then we have a third group of countries, which produce high-quality exports of investment goods because China currently relies so heavily on investment. A sharp drop in investment, as I said, would have a significant impact on exporters of investment goods. Even for large economies, like Japan or Germany, for example, a 1 percentage point decline in investment in China would have an impact of about .1 percent in Germany and Japan, which is not trivial, and quite significant given the size of these economies.

IMF Survey online: Very significant. It just goes to show how closely integrated China is with the rest of the world. One of those interlinkages, which has received a lot of attention in recent years, is China’s growing ties with Africa. So what might the channels of transmission be there if China were to experience a slowdown?

Rodlauer: The soft landing that China is trying to engineer and is currently on track toward achieving would have a moderate impact on the global economy. But were there to be a much sharper fall, it would be serious. For Africa, as I said, commodity exports is one side, but as you know, China is also investing a lot in many parts of the world, including in Africa. So were there to be a sharp drop in income and a sharp drop in the economy in China, investment outward from China to the rest of the world would probably also be affected and that would have an impact on Africa, which is currently benefiting from significant inflows of investment from China.

IMF Survey online: How pessimistic or how optimistic should we be about the Chinese economy and the implications of moderating growth, given its importance in the world?

Rodlauer: I am an optimist for China. I’ve been an optimist for many years. And if you look at the last two decades of growth and of success in China, you cannot help but be a very excited optimist.

Looking forward, again, the opportunities are tremendous. But I have always said: China is a story of huge successes, but also of huge challenges. So one must not forget, by mentioning almost in one breath, all the tremendous opportunities for continuing growth, for continuing success, but also, the huge challenges that this economy faces. China has been successful in mastering them in the past, and we are confident that with the right kind of policies, with the right kind of advice, and the right kind of global collaboration, China will be able to go forward and master those challenges as well.