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80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 China GDP growth y oy Japan GDP growth y oy G7 GDP growth y oy Korea GDP growth y oy
Source: Datastream
2004 2005 2006 2007 2008 2009 2010 2011 2012 China consumption contribution of GDP growth China inv estments contribution of GDP growth China net exports contribution of GDP growth
Source : Datastream
Contact
Dr. Alessandro Bee Economist +41 58 317 9283 alessandro.bee@jsafrasarasin.com
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 China deposit rate 1 y ear nominal China deposit rate 1 y ear real
potential of Chinas export markets in the West has greatly diminished because the industrialised world continues to suffer the consequences of the Great Recession. 2) Regarding the domestic economy, China faces a decline in its working age population in the coming years, which could potentially accelerate wage growth. 3) In terms of investments, there are increasing signs that the artificial stimulation of investments has resulted in a misallocation of resources. The corporate debt bubble and real estate bubble are evidence of this. There is a risk that investments in future will no longer be able to boost production to the desired extent. Chinas reform plans Chinas leadership recently announced wideranging reforms at the third plenary session of the 18th Central Committee of the Communist Party of China. They are designed to reduce the economys external and internal imbalances (rebalancing). The central focus of this rebalancing process is to strengthen consumption. Setting up a social safety net is an important aspect of this endeavour. Strengthening consumption goes hand in hand with changing the structure of the economy from the current model of an export-based manufacturing industry to that of a domestic-oriented services sector. Since a large part of Chinas manufacturing industry is in the hands of quasi-government organisations, whereas the services sector is dominated by privately owned companies, this also entails the privatisation of the economy. Also of central importance is financial liberalisation, which should spell the end of financial repression in China. On the one hand, consumers will have access to new resources, while on the other hand, the introduction of market-based capital costs reduces the risk of bad investments. The reform plans recently outlined by the Chinese authorities address all these key issues; however, it is the implementation phase that usually determines whether reforms are successful. Nonetheless, it must be said that Chinas leadership has successfully executed its reform policies over the last 30 years, which gives rise to the hope that this time will be no different. Two transition scenarios There are two potential scenarios for Chinas impending rebalancing. In the optimistic scenario, China manages to maintain the current economic model for several years and, as a result, generates high growth
rates. Supported by strong growth rates, the Chinese government manages to gradually introduce the pending reforms and the country makes a smooth transition to the new economic model. In the pessimistic scenario, the current economic model very quickly loses traction and momentum rapidly subsides. But as it will almost certainly take a decade for the reforms to kick in, China will face a very difficult rebalancing process and run the risk of a hard landing, i.e. a very severe downturn resulting in a stagnation or even in a recession. Intact growth driver It is therefore of paramount importance whether the current economic model can deliver high growth rates in the coming years as well. The deteriorating demographics and dwindling demand from the West are bound to slow growth. However, one should not overlook the fact that the level of Chinas economic development even after the powerful growth rates recorded in recent years is still relatively low. Chinas per capita capital stock is now at the same level with that of Japan in the early 1970s and Koreas capital stock in the 1980s. Yet both countries still managed to record very high rates of investment in the subsequent period (Figure 4). The urbanisation picture looks similar. Chinas urban population is currently at a similar level with that of Korea in the 1970s (shown in Figure 5). Koreas urbanisation increased to 80% in 2000, which suggests China still has potential. The untapped potential of urbanisation and capital stock gives rise to the hope that Chinas old economic model is still in a position to generate high growth rates. This suggests China should manage to rebalance its economy without encountering serious frictions or a hard landing.
Source: Datastream
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1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 China inv estment/GDP ratio Korea inv estment/GDP ratio Japan inv estment/GDP ratio
Source: Datastream
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 China urban population in % of total Korea urban population in % of total Japan urban population in % of total
Source: Datastream
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