China's geo-economic pivot

Amid economic troubles, China's changing geopolitical outlook opens the door for renewed engagement with India

It may appear strange that a 5.2 per cent gross domestic product (GDP) growth rate in an economy as large as China (now estimated at $17.52 trillion) recorded in 2023 is considered evidence of a significant slowdown. And this growth has been achieved with zero inflation at a time when the challenge for most other advanced and emerging economies has been persistent inflation. It is true that China’s exports and imports fell by 4.6 per cent and 5.5 per cent year-on-year in 2023, but the country remains the world’s largest trading power, constituting about 15 per cent of world trade. It is a world leader in electric vehicles. Nearly 60 per cent of the manufacturing for solar and wind energy, as well as storage batteries, critical to the transition away from fossil fuels, is located in China. The country is one of the leaders in artificial intelligence (AI) research and application, just behind the US. Therefore, is not talk of a “China peak” or secular economic stagnation —“Japanification”— premature?

The Chinese economy is facing both short-term and long-term headwinds. The source of the greatest economic vulnerability is the property crisis, which continues to expand, with ripple effects throughout the domestic and even external economy. Having constituted 30 per cent of total economic activity and a significant part of household wealth, de-leveraging in this sector is impacting overall financial stability. According to a recent study, 70 per cent of family assets in China are held in property. Housing sales are down by 40 per cent since 2021, and the real estate sector overall has shrunk by 9.6 per cent. Two-thirds of property developers have missed bond payments and the largest of these, Evergrande, has been ordered to liquidate by a court in Hong Kong where it was listed. There is a real danger of a domino effect, with contagion spreading to other major developers.

The Chinese stock market had been the other source of wealth creation for Chinese households. Share prices of Chinese entities listed on Hong Kong, Shanghai, Shenzhen and New York exchanges have lost $7 trillion since early 2021. In local Chinese exchanges, the decline has been over $6 trillion. The chilling effect on households is compounded by reports that salary packages have, for the first time in 40 years, been cut by as much as 30 per cent. Even if this is an exaggeration, taken together, these add up to a huge wealth wipe-out whose consequences are being seen in depressed consumer spending. The threat of deflation stems mainly from this.

The property crisis has also led to acute strains in local government finances. Their total debt exposure stands at $13 trillion. Local government financing vehicles, which have been used to fund infrastructure building, stand on the brink of widespread default. Four out of five have missed interest payments repeatedly. Recently, there was a directive from the central government to local governments to cut back even on infrastructure projects that had already started. While there is a general expectation that the central government would willy-nilly bail them out, the macro-financial situation is also fragile. China’s overall debt overhang is currently 272.15 per cent of its GDP. While China has been able to sustain a decent rate of GDP growth, even this has been fuelled by rising and unsustainable debt. Any serious effort to deleverage this will inevitably result in lower GDP growth even if a financial crisis is averted.

Will the recession in the traditional sources of Chinese growth, such as the property sector, be compensated by the new technology sectors in which China is undoubtedly a leader?

Not in the short to medium term, since these sectors are still relatively small in relation to the overall economy.

The prospects for the Chinese economy are also impacted negatively by longer-term headwinds, with the demographic factor perhaps being the most significant. China’s population declined for the first time in 2022 since the 1960s, by 850,000. In 2023, the decline continued with a larger drop of 2.08 million. This trend is likely to continue. It is estimated by some population experts that the country’s working age population may decline by 270 million by 2049, when China will celebrate the centenary of the founding of the People’s Republic.

Could China’s heavy investment in advanced technologies, such as AI or robotics, enable it to sustain a decent rate of growth despite a declining population, and enable productivity gains? The policy commitment is in place, as is focused implementation. China’s top leader, Xi Jinping, has declared that the battleground of the future will be technology, and that China must position itself at the forefront in all key disciplines. China’s R&D spending as a percentage of GDP is now 2.5 per cent, still behind the US, but catching up. While there are inconsistencies in Chinese reporting, it is estimated that in 2020, Chinese R&D expenditure was $563 billion, compared to $672 billion for the US. This is already having a significant pay-off and will continue to be a key element in sustaining China’s economic rise.

China has built up, over the years, a very significant scientific and technical manpower pool, which is still expanding. Even if there are economic disruptions in the short and medium term, this invaluable asset will enable a bounce-back. The question is whether China can achieve a relatively smooth transition from its current economic structure to a new one?

How will geopolitics be impacted by these trends?

Preoccupation with domestic economic challenges will lead to a lower Chinese external economic profile. This is already visible in the drawing back from the more ambitious Belt and Road initiatives. This could open up space for India’s economic re-engagement on a larger scale in the sub-continental neighbourhood.

Domestic and external economic challenges are leading China to step back from its in-your-face “Wolf-Warrior” diplomacy. This is reflected in recent improvements in US-China relations, the muted response to the re-election of the independence-leaning Democratic Progressive Party in Taiwan, and a more friendly posture towards Europe as well as Southeast Asia. China is also reinforcing its image and role as a leading country of the Global South, whereas earlier it was emphasising its great power status in the same league as the US. This puts it in competition with India, which aspires to the role of a leader and voice for the Global South. The changed geopolitical outlook that China displays may open up prospects for an India-China re-engagement and restoration of normal relations. This is worth a cautious exploration.

The writer is a former foreign secretary and an honorary fellow, Centre for Policy Research