By Amita Batra*
A big event this October was President Xi’s address to the 19th Congress of the Communist Party of China (CPC). While marking his attainment of cult status, Xi’s speech, as widely reported, is also a definitive statement of China’s ambition to be centre stage in global power. Of note, among other aspects, is the statement made in the context of the economy. There is a clear recognition in the speech about what China needs to do to consolidate its economic might. Xi’s speech included references to further opening the economy to trade and investment, pushing ahead with economic reforms in the financial sector and foreign exchange rate, and encourage innovation to make Chinese industry move up the value chain. While the speech does not lay out a concrete action plan, the recent past provides evidence that it may not be hard for China to convert intent into reality. The following facets of China’s growth and reform may therefore help in better understanding the context and accordingly formulate expectations and future preparedness.
First, even though the macroeconomic outlook for China has for almost a decade now included the possibility of a crisis on account of increasing domestic debt levels, China has continued to be the fastest growing economy for almost the entire period. Dented by the global financial crisis, the Chinese economy has no doubt slowed down and the double digit growth rates are a thing of the past – but the growth trajectory is not derailed. In fact, the Chinese economy has been consistently performing at an annual average rate of growth of around 7 per cent. Recent growth projections by international agencies predict a positive outlook for the next few years. According to the International Monetary Fund (IMF), China is expected to grow at an average rate of growth of 6.4 per cent relative to 2016’s 6.0 per cent, and upwards over the period 2017-2021. The now consistent for many years risk to the outlook of rising government, corporate and household debt remains, and is expected to increase to 300 per cent of GDP by 2021, up from 200 per cent in 2016. Even though this creates the possibility of a sharp decline in growth in the medium-term, the IMF also reports that with a greater emphasis on sustainability of the growth process there is evidence of deleveraging by the Chinese. The ‘credit to GDP gap’ that is excessive relative to historical trend and the required ratio for long-term GDP growth is also reported to be showing signs of narrowing down. In addition, the 13th five year plan (FYP), by addressing corporate debt-related vulnerabilities and financial stability considerations, provided indication of a clear recognition of the problem. Significantly, also to be noted is the fact that banks in China are state-owned so that debt restructuring as and when undertaken may not be difficult and hence may never culminate in an economic crisis for the country. Some restructuring of state-owned enterprises is already underway in China.
Second, innovation-based movement up the value chain has been the Chinese mission for some time. China’s 13th FYP placed significant focus on innovation. The ambitious ‘made in China 2025’ strategy that is aimed at achieving dominance in high tech industry also identifies innovation as the main motivating force. China’s structure of comparative advantage has evolved in recent decades with underlying dynamism, shifting from low value-added to high value-added industries. There is evidence of China evolving from its ‘factory of the world’ status that was achieved through perfecting its assembly line production processes. Recent trade trends for China show a greater decline in imports relative to exports. This is indicative of the fact that China’s participation in global value chains (GVC) is increasingly getting domestically consolidated, and more and more intermediate inputs are being sourced domestically rather than through imports. While in the initial stages of GVC participation, foreign direct investment (FDI) and technology transfers played an important role in the up-gradation of China’s comparative advantage structure, the recent development of domestic intermediate goods replacing imports is based on innovation. In the 2016 World Intellectual Property Organisation (WIPO) Global Innovation Index (GII), China’s performance was among the 25 most innovative economies in a set of 128 countries. According to the GII report this is a first for a middle-income country to join the ranks of highly developed economies that have dominated the index since its inception nine years ago. China has continued its upward movement in the index and ranked higher at 22nd on the GII in 2017. China’s research and development (R&D) investment has grown in the last two decades with the rate of growth being greater than that of the top performing US and EU. As per UNESCO data, China is the second largest performer in terms of absolute amount of R&D spending and accounts for 20 per cent of the world expenditure on R&D following the US, which accounts for a 30 per cent share.
Third, moving towards a floating exchange rate system is imperative for China and has been long overdue. Some movement towards greater market orientation and transparency was initiated in August 2015. Additional reforms towards evolving a mechanism for the central parity rate that reflects the demand-supply conditions in the foreign exchange market, linkages with a basket of currencies, and is based on previous day closing rate were indicated in 2016. However, the introduction later of a ‘countercyclical factor’ has invited criticism. The opacity with regard to its constituents and application to manage market and exchange rate volatility has once again revealed the ever present state control of the market mechanism.
Summing up, while greater transparency and rules-based economic operations are undoubtedly required for China to be truly on the path to greater openness and market orientation, its sustained progress on the ‘Socialism with Chinese characteristics’ path may continue to ensure growth, and hence potential for expanding economic influence.
* Amita Batra
Professor of Economics, Centre for South Asian Studies, SIS, JNU