Focus on China

The twin investment and export growth engines are losing horsepower

Chinese economic growth has slowed over two consecutive quarters, with Q2 coming in at 7.5% year on year. However, despite this slight loss of momentum, we still expect China to achieve its 7.5% growth target for 2013. Latest Purchasing Manufacturing Index data for August were positive in this respect.

Nonetheless, China’s historic growth strategy, which has relied on the twin engines of investment and exports, will need to evolve.

The government has recognized this. While investment in manufacturing and construction has created millions of jobs and kept the economy busy over the last decade, ghost towns have emerged across the nation in which few can afford to live. The National Audit Office’s latest audit on 36 local governments found debt had ballooned by 12.9% between 2010 and 2012. We expect this rapid accumulation of debt will take time to unwind.

China’s strategy of maintaining a relatively weak Renminbi and relying on low-cost exports is also evolving in response to rising wages and tensions with major trading partners. Monthly export growth has hovered around 0.2% since the start of 2013 compared to 2.0% over the same period in 2012.

Rebalancing to consumption

Figure 3GDP components of China and G7 (2011)

Figure 3 – GDP components of China and G7 (2011)

As China evolves, households will need to take on a bigger role in the economy (see Figure 3). Consumption accounts for only 35% of GDP, well below the G7 average. The scale of this consumption potential is formidable: if China’s consumption share of GDP was brought into line with its G7 peers, this would add over U$2 trillion to global consumer spending, roughly equivalent to the entire Russian economy in 2012.

The Chinese government has recognised the need for this shift, signalling a clear intention to quicken the pace of economic reforms. These include: strengthening the country’s social safety net to reduce the need for high precautionary savings; enforcing property protection (especially in rural areas); and reviewing the interest rate regime to enable better capital allocation in the economy.

The themes that will shape China’s next decade – transition from investment-led growth to consumption, financial liberalisation and a gradual move to a more freely floating exchange rate – will also shape global consumption. For most international businesses, this is a reason to be optimistic, but competition from domestic firms for a share of the fast-growing Chinese consumer market will remain intense.