OECD Economic Outlook, Volume 2018 Issue 1

China

Growth is set to soften somewhat in 2018‑19, as exports ease and investment slows. The current account surplus is projected to stabilise. Infrastructure investment, a major growth driver in recent years, is projected to slow further amid tightening monetary conditions and a more rigorous approval process for local government investment.

The monetary policy stance will remain neutral with a tightening bias, as mitigating financial risks has appropriately become a key policy priority. Shadow banking activities are increasingly being reined in and credit growth is slowing, while capital outflows moderated in early 2018 following a surge and the exchange rate has stabilised. Fiscal policy will remain supportive, but less so than in recent years as unauthorised local government investment is subject to increased scrutiny, which will strengthen fiscal sustainability. A series of new tax cuts have been announced, but the headline fiscal deficit will be kept under control by streamlining government organisations to contain public spending. Imminent risks stemming from trade frictions have receded, but the large number of unresolved issues will keep tensions high.

Growth has strengthened

Growth remained robust in 2017. Export growth surged, against the backdrop of the firming global recovery. Investment slackened amid greater scrutiny of infrastructure investment projects at the local level. Private investment, in contrast, surged in early 2018 as it is penetrating into new areas.

China

1. Housing prices are calculated from the 70 cities residential property price index. Chinese cities are commonly classified into six tiers according to their economic and administrative importance. Tier 1 comprises four cities (Beijing, Shanghai, Shenzhen and Guangzhou), Tier 2 eight, Tier 3 11 and Tier 4 47.

Source: OECD Economic Outlook 103 database; and CEIC database.

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In early 2018, consumption strengthened on the back of rising real incomes and a low unemployment rate. E‑commerce sales in particular have expanded very rapidly. Producer price inflation continued to moderate and consumer price inflation remains subdued.

China. Demand, output and prices

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Tightening monetary and expansionary fiscal policies aim at stabilising growth while addressing risks

Monetary policy retains a tightening bias and financial stability has become a major objective for the coming years. The new and high‑level Financial Stability and Development Committee under the State Council is expected to better safeguard financial stability, thanks to enhanced coordination. Its major task is to address potential areas of systemic risk. Shadow banking is shrinking due to the extension of the macro‑prudential policy framework to cover such activities. Implicit guarantees for asset management products will be phased out, which will reshape the landscape of this booming industry. More stringent regulations are being applied to interbank certificates of deposit, bringing down interbank activity sharply and enhancing financial stability. Corporate debt has stabilised, albeit at a high level of around 160% of GDP. Deleveraging needs to continue and will be spurred by a tightening of funding conditions. On the household side, debt continues to rise fast, notably in the form of credit card and other consumer loans. However, monetary tightening alone will not suffice to restore financial stability. Implicit guarantees to state‑owned enterprises and public entities need to be removed to create a level playing field, instil greater market discipline and achieve better credit risk pricing.

China

1. Shadow banking includes entrusted loans, trusted loans and undiscounted bankers' acceptance.

Source: Bank for International Settlements (BIS) ; and CEIC database.

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A series of capital control measures and the introduction of a new exchange rate fixing formula have arrested the trend of renminbi depreciation. Ahead of the new approval process effective from March 2018, capital outflows surged in late 2017, before moderating in early 2018. The rigorous process will cover sectors, such as real estate, hotels, sport clubs and entertainment, which have been major investment targets for Chinese firms in recent years. In addition, expectations of a stronger currency have reduced incentives to get funds out of the country by other innovative means.

Fiscal policy remains expansionary, following the announcement of a series of tax cuts, though less so than last year. Consumption will be boosted by a lower VAT rate across a wide range of products and a higher personal income tax threshold. The headline fiscal deficit is not projected to expand owing to efficiency gains as a result of the streamlining of government agencies. The overall deficit, in contrast, will expand slightly. Local government debt will be put under greater scrutiny, containing the increase of spending at the local level and strengthening sustainability. Controlling spending at the local level, however, is unlikely to be effective in the longer term as long as implicit guarantees to public entities prevail and sub‑national governments, in particular at the lowest levels, are burdened by unfunded spending mandates.

In addition to tax cuts, employment creation, helped by incentives to start a business, will also support consumption growth. However, without structural reforms to reduce precautionary saving, such as the provision of a better social safety net and higher‑quality public services, rebalancing will advance only gradually. Business investment will slow as funding conditions tighten and firms deleverage. The Belt and Road Initiative will keep infrastructure investment and exports strong. Recent measures to further open up to foreign investment will attract more foreign capital, contributing to greater efficiency in many industries, notably in the service sector. Restrictions on house purchases and sales as well as on mortgage lending have started to impact the housing market, but prices will remain elevated as long as supply is constrained.

Growth has picked up but more sustainable drivers are needed

GDP growth is projected to slow in the next two years as exports moderate and greater emphasis is put on the quality rather than the pace of growth. Inflation is expected to remain subdued as producer price growth is moderating and there is no imminent pressure on consumer prices either. Reining in shadow banking will enhance financial stability and transparency, but may cause funding difficulties for smaller banks. Corporate deleveraging is necessary to restore balance sheets amid rising debt service costs. Slower deleveraging would result in stronger growth in the short term but larger imbalances later. Moderating house price inflation may hold back housing investment somewhat, but is necessary to reduce imbalances. A weaker fiscal stimulus might adversely affect growth, but would reduce the risk of a further build‑up of implicit government liabilities. A faster‑than‑expected roll-out of projects under the aegis of the Belt and Road Initiative would boost Chinese exports of goods and services, and hence, growth. Trade frictions may adversely affect some export‑oriented sectors and firms, in particular those highly exposed to affected markets. A shrinking bilateral trade surplus alone is unlikely to resolve all contentious issues, which require further dialogue.