Economic recoveries come in many forms, often likened to letters. There is the sharp V-shaped rebound, the gradual U-shaped upturn and the volatile W-shaped take-off. But how to describe the descent of an economy from high-speed growth?
Chinese planners have seized on “L” as their letter of choice. The suggestion is that, after an initial lurch downward, growth will coast along a new plateau for years.
Hokey as all this letter-based analysis might sound, it has been an accurate depiction of China’s recent economic trajectory.
The vertical part of the L came in the drop from double-digit growth after 2010. From the start of 2015 until late in 2017, GDP growth year-on-year has remained in the 6.7-7.0% range every quarter, tracing out the L’s horizontal base (see chart).
Yet in 2018 there will be a clear break below that trendline. The question that is likely to unnerve global companies and investors is whether this will mark the end of the L, and the beginning of another big downshift in the Chinese economy.
Start with some appreciation for the marvel that is China’s growth. Although well off the double-digit pace of its recent past, steady expansion near 7% is remarkable for an economy with annual output of $11trn. In absolute terms China will have added more to its GDP in both 2016 and 2017 than in any previous year.
There have long been worries that this cannot last. Take your pick of problems: China had, and, in many cases, still has, too much investment, too little consumption, excessive debt, financial frailty and an over-reliance on the property sector. To varying degrees these remain threats to the economy. But the irrefutable fact at this point is that none has, in any significant way, succeeded in knocking China off course.
Many experts predict only a slight moderation in the coming year. The International Monetary Fund, for example, forecasts that China’s growth will edge down to 6.5% in 2018 from an expected 6.8% in 2017. The economy will, however, face much stiffer headwinds, largely of the government’s own making. After beating forecasts in 2017, the odds are that China will miss them in 2018.
A property rally that has run for the past two years will finally end. Left to its own devices, it could have kept on going for a while longer. But alarmed at the surge in prices and the speculative froth, the government leaned against the rally throughout much of 2017, steadily ratcheting up controls on mortgages and limits on house purchases. With its actions starting to bite at last, property sales will slow in 2018, as will construction.
Two other policies will also dampen economic activity. First, to contain financial risks after a decade-long debt binge, regulators have, since early 2017, been on the warpath.
They have slowed credit growth, reined in leverage in the insurance sector and pressed banks to bring shadow assets onto their balance-sheets. It has taken a while for these measures to hit the wider economy, but their impact will be felt more acutely in 2018.
Second, to clean up the environment, the government has ordered polluting factories to cut production. Similar orders by past administrations were all too readily ignored. Under Xi Jinping, China’s most powerful leader in years, companies are much quicker to fall into line. That is good news for the air that people breathe, but, in the short term at least, a drag on growth.
Investors are perennially edgy about China. A sharper-than-expected slowdown could easily lead to another bout of jitters in financial markets. Pessimistic takes about China’s “coming crash” were exceedingly rare in 2017; they will come back into fashion in 2018.
But although it is prudent to think about worst-case scenarios, the deceleration will only go so far. Given that the slowdown will stem in large part from regulatory crackdowns, mild relaxations—whether of the property restrictions, financial tightening or environmental policing—could help reverse, or at least cushion, it.
More fundamentally, there will also be evidence that China’s economy is on a somewhat more sustainable footing. While the government will shy away from deeper market reforms, that is a longer-term concern, not a pressing one.
In the meantime, a gradual rebalancing away from investment and towards consumption will gain ground. A shift to more labour-intensive service jobs will continue, supporting higher wages. Although the property rally will peter out, it will have made a sizeable dent in the nationwide stock of unsold housing.
The shape of things to come
China’s campaign to contain financial risks will also bear fruit. The focus in 2018 will be on restructuring the debt of state-owned companies. It will be an asset shuffle between banks and the government, not a market-led solution; but the outcome will still be healthier balance-sheets for some of the country’s most indebted firms.
China’s L-shaped growth pattern will lose its solid floor in 2018. But from a wider angle, it will still look much like that reassuring letter, albeit with a slightly jagged bottom.