OECD Economic Outlook November 2019 Country Note, China by OECD

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China Economic growth is projected to decline to 5.5% in 2021 as the economy continues to rebalance and trade tensions remain high. In 2019, frontloading of exports has helped to support activity, but increased tariffs will constrain growth going forward. Imports will slow further as demand for imported inputs eases, resulting in an increase in the current account surplus. Overall investment growth is no longer slowing thanks to government infrastructure projects and still robust real estate investment, although manufacturing investment growth is weak. Private consumption will grow steadily on the back of relatively strong disposable income gains. Inflation is easing, notwithstanding soaring prices of some consumption goods. Monetary conditions were tightened by restrictions on shadow banking but are now being eased to support economic activity. Broad-based cuts in minimum reserve requirements have been supplemented with a new pricing mechanism for the loan prime rate and a slight cut in the medium-term lending facility rate aiming at reducing the cost of borrowing. Fiscal policy, with a number of tax cuts, will remain supportive of consumption amid deteriorating consumer confidence. Infrastructure investment will be robust, and project financing is expected to benefit from relaxed own fund requirements. Growth remains robust Growth has weakened amid escalating trade tensions and global uncertainties, but frontloading of exports in the second half of 2019 ahead of expected new rounds of tariff increases is supporting industrial production. The rebalancing from investment to consumption has reduced the demand for imported capital goods and raw materials. Greater domestic production of inputs is also contributing to weaker import demand. As a result, the current account surplus has increased. Consumption has remained robust, thanks to steadily rising disposable incomes. Infrastructure investment has bottomed out thanks to the increase of special bond quotas and the easing of rules for enterprise bond issuance. Business investment growth has remained stable, in particular in services, though manufacturing investment growth has slowed significantly. Real estate investment growth has been stable on the back of strong demand for private housing and continuing large-scale reconstruction of shantytowns. New housing starts, however, are moderating, pointing to weaker growth of residential investment in the future. This could potentially reduce vacancy rates but could also inflate the property bubble in cities where demand is robust.

OECD ECONOMIC OUTLOOK, VOLUME 2019 ISSUE 2: PRELIMINARY VERSION ÂŠ OECD 2019

104 ď ź

China 1 Manufacturing investment growth has stabilised at a low level

Trade growth has fallen sharply

Y-o-y % changes 10

Exports

Imports

Y-o-y % changes 50 40

30 20

10 4

0 -10

-20 0

2018

2019

2018

2019

-30

Note: All data are in nominal terms. Source: CEIC. StatLink 2 https://doi.org/10.1787/888934045164

China: Demand, output and prices

2016

2017

Current prices CNY trillion

China GDP at market prices Total domestic demand Exports of goods and services Imports of goods and services Net exports1 Memorandum items GDP deflator Consumer price index General government financial balance2 (% of GDP) Headline government financial balance3 (% of GDP) Current account balance (% of GDP)

2018

2019

2020

2021

Percentage changes, volume (2015 prices)

74.0 72.3 14.6 12.9 1.7

6.8 5.9 11.4 6.9 1.1

6.6 7.1 3.6 5.7 -0.3

6.2 5.2 3.7 -1.7 1.1

5.7 5.9 1.8 2.0 0.0

5.5 5.5 2.5 1.7 0.2

_ _ _ _ _

3.8 1.5 -3.0 -2.9 1.6

2.9 1.9 -3.1 -2.6 0.4

1.5 2.5 -3.3 -2.8 1.4

1.5 2.2 -3.6 -3.0 1.4

2.1 1.9 -3.8 -3.0 1.3

1. Contributions to changes in real GDP, actual amount in the first column. 2. Encompasses the balances of all four budget accounts (general account, government managed funds, social security funds and the state-owned capital management account). 3. The headline fiscal balance is the official balance defined as the difference between revenues and outlays. Revenues include: general budget revenue, revenue from the central stabilisation fund and sub-national budget adjustment. Outlays include: general budget spending, replenishment of the central stabilisation fund and repayment of principal on sub-national debt. Source: OECD Economic Outlook 106 database.

StatLink 2 https://doi.org/10.1787/888934046247

OECD ECONOMIC OUTLOOK, VOLUME 2019 ISSUE 2: PRELIMINARY VERSION ÂŠ OECD 2019

 105

China 2 Lending rates are high Annual rate 18

Corporate debt remains high Y-o-y % changes 18

% of GDP 170

136

102

← Informal lending rate

General government

← Weighted average lending rate Nominal GDP →

2013

2014

2015

2016

Households and NPISHs Non-financial corporations

2017

2018

2019

2012

2014

2016

2018

Source: CEIC; and BIS. StatLink 2 https://doi.org/10.1787/888934045183

Fiscal stimulus will support growth alongside moderate monetary easing Fiscal stimulus will continue to hold up growth with the recent acceleration of new project approvals and large-scale projects in the coming years in roads, railways, telecommunications (including rolling out of 5G) and energy, and the continued reconstruction of dilapidated houses. Amid falling investment efficiency, greater attention should be paid to the pricing of risk to reduce the misallocation of capital. Removal of implicit guarantees to state-owned enterprises and other public entities would help. The impact of tax cuts aimed at boosting consumption may be mitigated by adverse confidence effects. Relaxation on car purchases and other measures may provide a short-term lift to consumption (and aggravate pollution problems), but to fully stimulate consumption, structural reforms should be accelerated. In particular, urbanisation and more inclusive public policies are needed. Abolishing the differences in public services that people with different household registrations can access would create more equal opportunities. A minimum level of public services should be ensured through better allocation of resources to provide more equal opportunities to individuals regardless of their place of birth. Central funding for basic public services, such as education and health, is needed to ensure a sufficient level of service provision. Monetary policy was tightened somewhat over the past couple of years by restrictions put on shadow banking and wealth management activities, which were necessary to maintain financial stability. This heightened risk aversion and affected disproportionately smaller banks and private and smaller firms. Some smaller banks relying on interbank funding defaulted, which required government intervention. As the government did not bail out all creditors, this should sharpen risk perception and goes in the right direction toward phasing out implicit guarantees. Private and small firms have difficulty in accessing formal lending channels and face continued high interest rates. To drive down borrowing costs, the central bank lowered the one-year medium-term lending facility rate by 5 basis points in early November. It had earlier changed the pricing mechanism for loan prime rates, linking the one-year lending rate on new corporate borrowing to rates set during open market operations (i.e. the PBOC’s medium-term lending facility, the MLF), which is determined by broader financial system demand for central bank liquidity. Getting access to loans at rates that better reflect funding conditions will improve the transmission mechanism. In addition, the lowering of the reserve

106  requirement ratio for the so-called city commercial banks – smaller banks with local government ownership that mostly serve the local economy – in addition to the across-the-board cut should help to alleviate the credit squeeze for micro, small and private enterprises. Corporate debt remains high at 155% of GDP, in particular in the state-owned sector.

Growth is projected to slow Growth is projected to slow further as the last announced round of tariff increases takes effect and trade tensions continue to weigh on manufacturing output and investment. The additional announcements for tariff increases this year will shave off between 0.3-0.4 percentage points of GDP growth in 2020. This is in addition to the slowing effect of the long-term rebalancing of growth. Cuts in the average import tariff rate by China over the past year (tariff increases on imports from the United States have been more than offset by tariff reductions on other imports), an increased VAT refund on exported products and lowering of export taxes will mitigate the impact of trade tensions. In addition to the measures reducing the costs of doing business, easing producer price inflation will also strengthen competitiveness and exports in 2020-21. Consumer price inflation will nonetheless pick up somewhat due to surging fresh food prices, partly reflecting African swine fever, but these one-off pressures will remain benign. Depreciation of the bilateral US dollar exchange rate may curb overseas tourism somewhat, slightly lifting the current account surplus. A major upside risk is the alleviation of trade tensions, which would not only lift exports but also manufacturing output and investment. It would also improve consumer confidence, thus leading to stronger growth than projected. Excessive monetary easing would further inflate the property bubble, and thus lift growth, but would imply greater risks down the road. Downside risks stem from financial conditions: greater risk aversion and difficulties at smaller banks may lead to a credit crunch at private and smaller firms. An acceleration in corporate deleveraging would help to restore balance sheets amid high debt service costs, but would slow growth in the short term. A weaker fiscal stimulus, to avoid a further build-up of implicit government liabilities, would adversely affect growth. A fall in house prices would hurt recent buyers through the wealth effect and borrowers through the collateral effect.