Can China navigate the storm? New economic hurdles may test resilience

While it has successfully weathered economic challenges before, this time is different

China recently introduced an aggressive monetary and fiscal stimulus to revive its flagging economy. Its 2024 growth target of 5 per cent was at risk, as reflected in a loss of momentum, with gross domestic product (GDP) growth slowing to 4.7 per cent in Q2 2024, down from 5.3 per cent in Q1. GDP growth in Q3 was at 4.6 per cent, the print for which came after the announcement of the stimulus package. 

 

The Chinese economy has faced headwinds post-pandemic. However, it had already begun to slow down before the pandemic, with growth decelerating from 10.6 per cent in 2010 to 6.0 in 2019. This situation was further worsened by China’s stringent lockdowns under its zero-Covid policy. While the monetary and fiscal measures may help support growth in the near term, the Chinese economy faces three deep-rooted structural issues.

 

First, China has followed an investment-led growth model, unlike India and many other emerging market economies (EMEs), where consumption has been the mainstay of aggregate demand.  Investment (gross fixed capital formation as a percentage of GDP) in China rose markedly from 2002 onwards, averaging 38.3 per cent during 2002–08, compared with an average rate of 30.4 per cent over the preceding 22 years (1980–2001). Investment accelerated further after the North Atlantic Financial Crisis (NAFC) in 2008, averaging 43.0 per cent from 2009 to 2022. Though the investment rate declined from its peak of 44.5 per cent in 2013 to 41.9 per cent in 2022, it remains far higher than that of many other EMEs. China has also been a massive export surplus country.

 

This investment- and export-led model of China has been facilitated by a high savings rate, averaging 42 per cent over the past 50 years. This far outstrips the next highest savings rate among major EMEs, 31 per cent in Malaysia, and the global average of 22 per cent. Consequently, consumption in China has been low, at 53 per cent of GDP (2002), compared with 71 per cent in India and over 80 per cent in Brazil, Mexico, and South Africa (2023).

 

Investment in the property sector has become a key driver of growth, with its share in GDP rising from 16 per cent in 2011 to a peak of 29 per cent, before moderating to 24 per cent in 2023. The property sector, which stores 70 per cent of household wealth, has been experiencing a downturn, caused by high debt and rising defaults.  

 

Excessively high savings and low consumption have become increasingly unsustainable, as factors such as the collapse of the property market have created a negative wealth effect and eroded consumer confidence. Although authorities indicated a shift toward rebalancing the economy after the 2008 NAFC, little has changed. The  International Monetary Fund has urged authorities to implement structural reforms to strengthen the social safety net and boost household consumption.

 

Second, China is undergoing profound demographic shifts with a shrinking and ageing population. Its population has peaked, and the working age population is now beginning to decline. The United Nations projects China’s population to gradually decline from 1.4 billion in 2022 to 1.3 billion by 2050, and further to 1.1 billion by 2070. The old-age dependency ratio (the population aged 65+ as a percentage of the working-age population, aged 15-64) is expected to rise sharply — from 20.7 per cent in 2023 to 51.5 per cent by 2050, and further to 68.9 per cent by 2070. This is in sharp contrast to the much lower dependency ratio projected for India, at 10.4 per cent, 22.4 per cent, and 38 per cent over the same period.

 

In 2020, 14 per cent of China’s population was over 64 years old, compared with just 7 per cent in India. By 2070, nearly 59 per cent of people in China will be over the age of 64, compared with 30 per cent in India.

 

Demography experts believe that the ageing process in China has set in at a relatively early stage of development and at an accelerated pace compared to what most countries have experienced. The smaller workforce and ageing population will weigh on growth, besides putting pressure on its social safety net and healthcare system.

 

Third, China’s debt situation has been worsening, with total debt ballooning by 64 per cent from RMB 252 trillion in 2019 (254 per cent of GDP) to RMB 413 trillion in 2024 (312 per cent of GDP). The bulk of this debt is held by the corporate sector (40 per cent), followed by households (21 per cent) and the general government (19 per cent). China’s debt-GDP ratio has risen, on an average, by about 11 percentage points every year since 2015. Its elevated and rising debt has impacted its growth prospects, and some experts believe that it could lead to a financial meltdown.

 

China faces persistent deflationary pressure due to weak household demand, which has been hit by a crisis in the property market and weak consumer confidence. Inflation based on the consumer price index has remained at or below 0.7 per cent since March 2023, while that based on producer price index fell by 2.8 per cent in September 2024, marking the 24th consecutive month of producer price deflation and the fastest pace of decline in the last six months. There is a risk of deflationary tendencies getting entrenched. 

 

The collapse of the property sector in China and deflation have drawn comparisons with Japan, which, after the real estate crash in the mid-1990s, was plagued by deflation, entering what is referred to as the lost decades. However, there remains a major difference. In Japan, plummeting share prices severely damaged its banking system, leading to bankruptcies of several major financial institutions. In China, the fallout from the collapse of the property market on the banking sector has largely been contained so far, though it is difficult to predict how the situation may evolve going forward.

 

China has faced many economic challenges in the past, and each time it has managed to muddle through. However, the macroeconomic situation this time is far more complicated, and it remains to be seen how China will navigate it. The current global macroeconomic environment is also not as conducive as it was in the past. In addition, China’s strained relations with the transatlantic only make its task of steering the economy much more challenging.

 

The author is senior fellow, Centre for Social and Economic Progress, New Delhi, and a former executive director of RBI