China at a crossroads

05 September 2016

Standard Life Investments, the global investment manager, has analysed the challenges facing China as it attempts to transition from middle to high-income status. In the latest edition of Global Horizons, Alex Wolf, Emerging Markets Economist, examines a number of the complex issues the country faces at this point in its economic development, and considers what structural reforms are required to avoid a slowdown in economic growth.

Alex Wolf

Alex commented “By our estimates, the economy’s growth rate has slowed to 5% p.a. as its model of credit-fuelled, state investment-led growth has become exhausted and increasingly counter-productive. Although the Chinese authorities recognise the need to rebalance and restructure the economy, they are facing a range of difficult trade-offs:

  • Controlled deleveraging is necessary to promote more sustainable growth in the future but requires accepting lower growth today.
  • Financial sector reforms are necessary to underpin consumption-led growth and better resource allocation, but will entail a loss of direct control over credit growth, resource allocation, and the exchange rate for policymakers.
  • Reform of state-owned enterprises (SOEs) and further deregulation of product markets are needed to lift innovation and increase productivity growth, but require the state to play a regulatory rather than competing role within the economy.”

Alex continued “In a best-case scenario where structural reforms are accelerated, the economy could maintain growth in the range of 4-5% per annum over the next decade. If the authorities fail to deliver on reforms then China risks falling into the middle income trap, with potential growth slowing to as low as 2%.”