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Rebalancing? What rebalancing?

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Lost amid the attention paid to a potential trade war, there is a new debate emerging over whether China’s economy is finally rebalancing, with commentators such as Martin Wolf of the Financial Times recently proclaiming “the Chinese economy is rebalancing, at last”. We, however, would argue the opposite; not only are there scant signs that China is rebalancing, but most data shows rebalancing reversed last year. While it is undeniable that the Chinese economy made progress over the years 2014-2016, market-unfriendly policies enacted since 2016 have stalled or reversed some of this rebalancing progress.

Not rebalancing Weakening consumption

Rebalancing in China entails the idea that the economy moves away from debt-fuelled investment towards a consumption and services-driven economy. Indeed, this is what China did in the years following the crisis; household consumption as a share of GDP rose from a low of 35.5% in 2010 to 39.5% in 2016 – still far from pre-crisis highs, but nonetheless the economy was progressing in the right direction. As the economy slowed sharply in 2014 and 2015, China responded with old-fashioned stimulus and Mao-era production quotas, aimed at boosting ‘old China’ growth drivers – namely heavy industry and the property sector, all while household credit continued to fuel growth. At the same time, another old growth driver returned: exports posted the largest annual contribution to growth in 2017 since the years before the crisis. In other words, China has done the opposite of rebalancing over the past two years, and most data so far this year point to the same trend. When the economy began to slow in 2014, market pressures actually forced rebalancing. The property sector was slowing after years of breakneck growth, investment was slowing due to declining returns on capital, and exports were slowing due to rising wages and currency appreciation. To let that trend continue would have brought about rebalancing; however, heavy government stimulus stalled that process.

In national accounts data the trend is clear, household consumption as a share of GDP fell in 2017 after six years of consistently rising. In addition, the industrial share of GDP rose in 2017 as did the investment share of GDP (see Chart 10). Real estate also bounced back: real estate investment as a share of total investment increased in 2017, after declining since 2011. In a country with more square meters per capita than most developed countries and a very high amount of vacant apartments, it could be argued that this trend decline should have continued. Neither does consumption data paint a rosy picture. Following a rise in early 2017, real consumption growth declined precipitously over the past three quarters, as measured through both retail sales and consumption expenditure (see Chart 11). From data on household income it is easy to see why consumption weakened last year. Rebalancing should mean a greater share of national income going to households, which would in turn support consumption, but household income as a share of GDP fell last year after steadily rising since 2011. There are bright spots. Certainly China’s economy appears less credit intensive now than in recent years. Moreover, one could say that stimulus measures were needed to fend off a deeper downturn. However, it is far too early to claim China is rebalancing.

Alex Wolf, Senior EM Economist