Betting on China

Despite a “difficult” past year of falling real estate prices， increasing defaults and ballooning local government debt， China has continued to defy the worst economic forecasts of doomsayers.

Fears of economic instability have been stoked by a deceleration in the economic growth rate of the country since 2010， said Justin Yifu Lin， professor and founding director of CCER and former chief economist and Senior Vice President of the World Bank. Naysayers expect numerous problems such as pollution， debt and income inequality to continue to create downward pressure on growth.

Why are so many critics pessimistic about the outlook for Chinas economy？ There are four obstacles that are making people unhappy at present， Lin said. Income disparities and corruption are making the poor unhappy， industrial pollution is making the rich unhappy， and the persistence of a relation-based society vs. the rule of law is making foreigners unhappy. “That is why even though the economic growth performance has been so good over the past 35 years many people think the economy is about to collapse，” Lin said.

According to Lin， the social and economic problems in China in part owe to the gradual approach the government has taken in transitioning from a planned economy to a market-based economy. Income disparities have arisen from protections and subsidies， which have also fostered pricing distortions， corruption and bribery. Lin claimed the pollution that has plagued the country with the rise of the manufacturing economy will ease with a transition to a service-based economy， and pointed out that currently government policy has increased regulation on polluters.

China is taking the right measures to tap into its growth potential， Lin stated， and will continue to be the main engine of the global economy. The economist said that as its economy matures beyond labor-intensive industry， China will become a main contributor of foreign direct investment， providing a window of opportunity for industrialization in lower-income countries， including those in Africa. Chinas consumption will continue to increase with rising incomes. It already accounts for one third and 25 percent respectively of the global luxury goods and car markets.

Rebalancing growth

Lu Feng， Director of CCERs China Macroeconomic Research Center， said the past 10 quarters of deceleration to less than 8-percent annual economic growth is due to accumulated imbalances of the previous decade of rapid growth. “Just like a runner needs to slow down to conserve and recover energy， Chinas economy is settling into a more sustainable pace.”

The Chinese Government has already taken steps to address the imbalances， including cooling down the housing market， reducing excessive leveraging of corporations and local governments and reshaping market expectations of an instant government bailout if things go south. The country is now in the final stages of adjustment to resolve the imbalances， Lu said， and economists have seen the “light at the end of the tunnel.”

Short-term problems like local govern- ment debt and real estate bubbles are one reason for reform， said Tang Min， an economist and Executive Vice Chairman at YouChange China Social Entrepreneur Foundation， and longer-term problems like an aging population and deteriorating environment also need to be addressed to avoid an economic “time bomb.”

“We still have many reforms to go to shift from a high-growth economy to a mediumgrowth economy focused on quality and efficiency over speed，” Tang said.

There have already been major social reforms such as relaxing the hukou （household registration） system， and one-child policy， and economic reforms such as expanding the Shanghai Free Trade Zone to allow more foreign investment.

There are five main areas for major reform this year， Tang said： maintaining economic stability， nurturing areas of new growth， poverty elimination， improving geographical income imbalances such as in the northeast region， and strengthening social welfare.

In terms of local debt， Chinas new budget law passed in August 2014 aims to correct the course of leveraging before it becomes a serious problem， said Hu Yifan， chief economist at Haitong International Securities Group Ltd. The size of the debts is still manageable and the resources of regional governments are still strong. Tax revenues are growing despite the economic deceleration and the Central Government is still seen as a last resort for indebted local governments. A bailout fund established for local government debt would help avoid any regional risks， she said.

Optimistic outlook

According to Lin， of the three drivers to growth—exports， investment and consumption， China must choose one path. Certainly China would be able to maintain its growth if the world economy continues a strong recovery and exports rise， but external demand is not reliable. Second， domestic consumption is already growing faster than in any other country， and will not be sustainable without income growth， he claimed. Income growth relies on technological innovation， industrial upgrades and improvement in in- frastructure. Therefore investment is the key to stable economic growth.

“Certainly， if you want to use investment as a driver for growth and to make the growth sustainable you need to have good investment opportunities， which give you a high economic and social return，” Lin said. “Luckily， China still has plenty of opportunities for that kind of good investment.”

As a middle-income country， China will still gain much from improvements in infrastructure， industrial upgrading and environmental protection. For example， only about 53 percent of people in China live in urban areas compared with an average of more than 80 percent in high-income countries —leaving plenty of room for further urbanization and growth of the market economy.

“When a high-income country has an economic slowdown it is very hard to find good areas for investment， but as a middleincome country we have plenty of room for further investment opportunities，” Lin stated.

China also has plenty of resources to fund an investment-led drive to economic growth， with $4 trillion in foreign reserves and a private savings rate of close to 50 percent of the annual GDP. It is not overly optimistic to expect Chinas economy to have decades of stable growth ahead， Lin claimed.

Regional benefits

Naysayers notwithstanding， Chinas success will lift hundreds of millions out of poverty and contribute to a stronger global economy， Lin said. Those who fear a Chinese collapse should breathe easy. Typical forecasting models that are used for other countries dont apply because China is still developing and has specific conditions that are different from the developed world.

“The current economic growth is good for China， good for the United States and good for the rest of the world，” Lin said.

Perhaps the first countries to benefit from Chinas economic growth are those along the Silk Road Economic Belt that will receive much of Chinas outbound global investment， said Qin Xiao， Chairman of the Boyuan Foundation and former Chairman of China Merchants Bank.

The initiative is expected to drive overseas investment for the next decade， including $76 billion in 2013. The region will also benefit from Chinese expertise in infrastructure development and will strengthen Chinese exports.

Chinas outward direct investment （ODI） is relatively high in mining and the financial sector， and there is a big potential for growth in utilities. Currently， the United States is the main target for most ODI stock， have totaled $21.9 billion. By 2025， Chinas ODI should have totaled $350 billion to $400 billion， second only to the United States， Qin said.