Chinese Growth - Is It a Fad?

                                CHINESE GROWTH: - IS IT A FAD?

China is the world’s largest economy on basis of purchasing power parity, manufacturer and holder of forex reserves. Since 1979 Chinese economy has grown at an average annual rate of 10% which has lifted around 679 million out of poverty. So why is China’s rise considered to be a fad or a bubble which will eventually burst? For proper analysis one has to look at the different economic reforms pursued by Chinese government over the years. Since 1979 after Mao Zedong’s era, China opened up its economy to foreign investment and launched incentives for farmers to sell certain portion of their crops on free market. Also reforms such as decentralisation of policymaking in different sectors gave local governments more power to pursue free market principles. China’s meteoric rise can be attributed to two factors which are large scale capital investment and rapid productivity growth.  Large scale capital investment was funded by huge domestic savings and foreign investment. When reforms started domestic savings were 32% of GDP and in 2013 it was at 50%.  FDI inflows increased from 2 billion in 1985 to 128 billion in 2014. Rapid productivity growth was achieved by reallocation of resources to more productive ones. Also a vast number of working class of people on low wages helped China to become manufacturing superpower as millions moved from agriculture to newly built cities for construction work and better living standards.

Despite the widespread economic reforms it is still not a completely free market economy and government still plays a major role in country’s economic development. There are persistent problems in the Chinese economy such as weak banking sector and growing national debt.  China’s banking sector is largely controlled by government and State Owned Enterprises’ (SOE) generally get loans at a lower rate than private firms. The SOE’s run like private companies and are listed on domestic and foreign exchanges even if Chinese government is the largest shareholder. SOE’s generally do not pay back their loans which has saddled banks with huge nonperforming loans. China’s debt situation can be seen from the figure (Source: - Morgan Stanley) which has risen to 245% of GDP mainly to fund huge infrastructure projects.  Other problems include large internal imbalance in savings and fixed investment.  Chinese government places restrictions on export of capital which leads to households putting a large share of their income in banks. The government also fixes the deposit rates which are generally lower than the inflation rate which leads to lower household income and savings are used to fund SOE’s. Chinese firms also do not pay dividends which enables them to retain most of their earnings. The global financial crisis led to decrease in demand for China’s export products which led to massive investment (such as 586 billion $ stimulus program in 2008) in fixed asset creation. China’s fixed asset investment accounted for 90% of its economic growth in 2009. Buildings and cities were being constructed just to generate economic activity which has led to creation of ghost cities. Also China faces huge demographic challenges due to its one child policy implemented in 1979. [pic 1]