The transition towards the new Chinese growth model poses serious challenges

An analysis by Sopanha Sa, Senior Asia Economist at Societe Generale

Over the last two years, China seems to have started shifting from a traditional manufacturing-investment led model towards a new services consumption driven economy.

While investment and industrial production continue to trend down, services remain an important driver of growth. Meanwhile, private consumption is being supported by a robust labour market and low inflation, so that economic rebalancing could occur but at the expense of a lower growth rate.

The authorities are trying to shift the growth model but seem to be concerned by the speed of the economic slowdown. In H1-15, they implemented pro-growth measures including easing of monetary policy, increases in public spending (investment infrastructures and social welfare) and tax cuts for the corporate sector. The risk of a hard landing is limited. The economy is expected to continue to gradually slow between 6 and 7% during the next two years. However, if activity deteriorates further, the authorities may face serious challenges in adjusting the economic policy. The use of the RMB depreciation as a support of exports could trigger a “currency war” as other regional currencies have been adjusting more rapidly and more strongly than the RMB to preserve their competitiveness. The authorities may then apply other traditional tools (such as stronger bank credit and higher infrastructure investment). However, this would exacerbate the large imbalances reflected in the high and rising indebtedness of the economy (240% of GDP from 150% in 2009) and in overcapacities in some sectors (coal, steel, etc.) and would delay the transition to the new growth model.

Extraordinary and sudden measures used by the authorities to stabilize financial markets last summer have introduced more uncertainty to the reform momentum. The stock market correction could make the authorities more reluctant to open the capital account and to deepen local capital markets. The RMB depreciation pressures could lead the authorities to be more cautious in the RMB internationalization process. All this put question marks behind the willingness of the authorities to liberalize the economy in directions that would permit to facilitate the development of a market-based economy.