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China’s rebalancing hits trading partners hard

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China is rebalancing its economy away from investments and exports towards consumption.

This has caused import growth to slow down, particularly in recent years. As China’s rebalancing is likely to continue over the next two years, its trading partners will most likely feel the impact.

China’s growth model has traditionally strongly relied on investments and exports. Chinese leadership is becoming aware that this growth model is not sustainable. High investment growth, often credit-financed, has created overcapacity in heavy industries such as mining and steel. At the same time, the share of consumption in GDP remained comparatively low.

In 2013, the Central Committee of the Communist Party proposed a series of major reforms to ensure a sustainable growth path, with consumption becoming the main growth-driver instead of investments and exports.

However, China’s progress on rebalancing is still limited. The share of consumption in GDP has increased only slightly, from 35.4 per cent in 2010 to 38.9 per cent in 2016, and remains lower than some of its poorer neighbouring countries.

While growth has become less investment-driven in recent years, the share of total investments in GDP remains high at 45 per cent.

Trade implications

Growth of private consumption was insufficient to compensate for lower investments. Over the past years, this has resulted in a decline in GDP growth, from 10.6 per cent in 2010 to 6.7 per cent in 2016. 

The trade implications of China’s slow, gradual rebalancing are still significant. The country has grown to be a major assembling hub, especially since its accession to the World TradeOrganisation (WTO) in 2001. In 2016, China had a global import and export market share of around 10 per cent.

The transition from exports and investments to consumption has a negative impact on import growth. This is because the import intensity (the share of spending falling on imported goods) of investments is around 50 per cent higher than that of consumption and that of exports is around 40 per cent higher.

Additionally, the global commodity price decline has also been weighing on import growth in recent years.

Lower investment

In volume terms, Chinese import growth slowed from an annual 22 per cent in 2010 to 0.7 per cent in 2015, and reached 3.8 per cent in 2016. Research by the International Monetary Fund (IMF) confirms that much of the import slowdown that occurred in 2014 and 2015 can be attributed to China’s rebalancing economy, particularly to lower investment and export growth.

The rebalancing of China’s economy has been felt by its trading partners, especially the countries for which China is an important export destination.

The Chinese government has retained its somewhat ambitious growth target of around 6.5 per cent for 2017 to strengthen social stability ahead of the 19th National Congress of the Communist Party in October this year.

Despite efforts to make growth more sustainable, imbalances in the economy created by high credit growth, especially in relation to state-owned enterprises (SOEs), remain substantial. Corporate liabilities have reached 166 per cent of GDP in Q4 of 2016, according to the Bank for International Settlements (BIS).

Increased borrowing by SOEs has contributed significantly to this rise, and SOEs account for almost half of corporate debt. Many SOEs work inefficiently, have weak management, and depend on state aid. They offer as low as one-third of the return on assets that private firms offer.

Budget constraints

Large-scale restructuring is necessary, even though it will cost millions of jobs. The overcapacity problem is worst in mining, steel, and other heavy industries. The Chinese authorities have started to tackle the issue by imposing budget constraints and starting to restructure SOE debt, but progress is currently slow.

The Chinese government is aiming for a slow, gradual adjustment of its economy, but it remains a balancing act. If credit growth slows too abruptly, it could crush investment and import growth.

Thus far, authorities have succeeded in preventing a hard landing. Import growth has slowed considerably in recent years, but has remained in positive territory.

China’s economy accounts for 10 per cent of global trade and 18 per cent of global GDP, so this turn inward would certainly have global spill-overs. The rebalancing of China’s economy negatively affects its trading partners due to the dramatic effects to its import growth.

The magnitude of the negative impact increases with the intensity of trade linkages, which depend on geographical proximity and whether a country is a large commodity exporter, since raw materials represent such a large input in China's investment projects.

Two scenarios

Using the Oxford Economics Global Economic Model we compared two scenarios, one being a baseline scenario in which authorities push forward with their rebalancing plan, keeping growth in 2017 and 2018 subdued around six per cent and an alternative high growth scenario in which the government deserts its efforts to transition to domestically driven growth, bringing investment, export and import growth rates back to pre-2014 levels and pushing GDP growth up to 7.2 per cent in 2017 and 7.6 per cent in 2018.

Comparing both scenarios, import growth was remarkably lower in the baseline scenario, averaging 5.8 per cent, three percentage points lower than the high growth scenario.

It also becomes clear that the impact on GDP if ongoing rebalancing occurs will be felt the strongest in Singapore (-1.4 per cent), Taiwan (-1.1 per cent), South Korea (-1.1 per cent), Chile (-1.0 per cent), and Qatar (-0.8 per cent). Singapore, Taiwan, and South Korea owe their close trade linkages to their geographical proximity to China. Chile and Qatar, on the other hand, export large quantities of commodities to China.

The negative impact of China’s rebalancing will be particularly felt by its closest trading partners, but also by the world economy.

Should the Communist Party maintain its rebalancing agenda as opposed to allowing higher, unsustainable, export-oriented growth, we conclude that the negative impact on global GDP growth could be 0.8 per cent over the period 2017-2018.

Mark Hoppe is managing director, ANZ, Atradius, a global risk management specialist.

www.atradius.com.au

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