A recent IMF Working Paper titled China’s Growth: Can Goldilocks Outgrow Bears? focuses on recent growth dynamics in China, and analyzes both cyclical positions and long-term growth prospects for the country. The paper was authored by IMF analysts Wojciech Maliszewski and Longmei Zhang.
Maliszewski and Zhang explain the thesis of their paper: “Currently, the ‘finance-neutral’ gap—our measure of the financial cycle—is large and positive, reflecting imbalances accumulated in the Chinese economy since the Global Financial Crisis. A period of slower growth is therefore both likely and needed in the near term to restore the economy to equilibrium. In the medium term, growth will slow as China moves closer to the technology frontier, but a steadfast implementation of reforms can ensure that China follows the path of the “Asia Tigers” and achieves successful convergence to high-income status.”
Slower growth, but no "hard landing" for Chinese economy
The paper highlights that Chinese GDP has been moving up at the average rate of almost 10% annually for almost 40 years. A number of analysts have suggested we are seeing the development of a Goldilocks economy in China, ie, not so hot as to drive high inflation, but not too cold to slip into recession, and many say that continuing stable economic growth is the most probable scenario for China for the next few years.
That said, worry is also increasing among China ‘bears’ that the current slowdown in economic activity is a prelude to a deeper economic malaise (see Xie, 2013). The bears argue that credit-financed investment related to the Financial Crisis and old-fashioned speculation has driven credit past the point that usually ends up with major growth slowdowns and even banking sector crises in other countries.
This credit surge has also led to a boom in the real estate sector, which is now facing growing inventories of unsold homes and increasing leverage across the sector. Maliszewski and Zhang note: "The spectrum of overinvestment or ‘malinvestment’ looms large, with a possibility of a sharp correction when demand created by the investment boom evaporates and the leverage proves unsustainable."
The authors also rightly suggest the key question is how much of China’s slowdown is temporary (cyclical) compared to long lasting (structural)? They note that growth patterns in developing markets usually see periods of impressive growth followed by long periods of low to no growth.
The report highlights that: "The concern is therefore not only about a cyclical growth slowdown typically experienced by mature economies, but a prolonged slump so often experienced in emerging markets. These fears are also fed by the observation that structural ‘imbalances’ in the Chinese economy—exceptionally high investment rates associated by some with ‘forced savings’ have further grown since the Great Financial Crisis, reducing investment efficiency and total factor productivity (TFP) growth."
Projections for China growth
Maliszewski and Zhang say that economic growth will slow down in the near-term. They emphasize that financial cycles play a significant role in shaping growth dynamics, and the Chinese economy is currently near the peak of a strong cycle driving the economy since the financial crisis. It is only reasonable to expect adjustment to slow the economy down and bring it closer to equilibrium.
The IMF analysts also highlight that the potential for growth is slowing. This is just part of the natural course of economic development as China moves toward advanced economy income levels. They say it is almost inevitable that growth will continue to slow for the time being.
China’s medium-term growth rate, however, is highly dependent on more structural reforms. If the Chinese government can continue to successfully implement reforms, then China should be able to mirror the historical experience of other fast-growing Asian economies such as Japan and Korea.
See full study below.