China’s GDP growth rate has been falling since the first quarter of 2010.
After more than 40 years of breathtaking expansion, it is not surprising that the economy has lost steam. Having fallen steadily from 10.6% in 2010 to 6% in 2019, it remains to be seen whether it will continue to decline and at what level it will stabilize.
Some in China argue that the dip was an inevitability caused by long-term structural factors. Others argue that to avoid a financial crisis, Beijing prioritized lowering its debt leverage ratio, even at the expense of growth.
But, while recognizing the role played by structural problems, the continuous decline in China’s GDP growth rate is to a large extent attributable to Beijing’s premature abandonment of expansionary fiscal and monetary policy due to the overblown fear of financial instability.
The steady weakening in growth does not demonstrate the inevitability of China’s economic decline. It is actually a self-fulfilling prophecy.
A lack of resolve to implement counter-cyclical policies will cause permanent damage to China’s growth potential – in turn weakening its financial stability.
At the beginning of 2022, Covid-19 abated in the country. The consensus was that China’s macroeconomic policy should aim to stabilize growth.
For the first time in many years, Beijing set an annual GDP growth target of 5.5%. The economy performed well until the Omicron variant struck Shanghai in March.
China’s consumer spending increased 6.7% year on year in the first two months. But it declined by 11.1% and 6.7% in April and May. Growth in fixed assets also slowed significantly.
The only comfort came from international trade.
In May, exports jumped 16.9% while imports increased 4.1%, implying that the growth rate of net exports was very high. But this growth pattern was neither sustainable nor desirable.
In the first quarter of 2022, China’s economy grew at 4.8% year on year, which was rather disappointing. The second-quarter figure then fell to just 0.4%.
Compared with other economies, China’s inflation rate is still moderate. The consumer price index (CPI) rose just 2.1% in May. China’s producer price index (PPI) was 6.4%. Although this figure is still a concern, it has decreased by half from its peak in October 2021.
The main challenge to China’s economy is recouping the loss in growth since March and achieving a rate not far off this year’s target of 5.5%.
So, Beijing has no choice but to use expansionary fiscal and monetary policy to stimulate the economy. Statistics just released show that this is just what the government is doing.
Given the weak consumption and investment demand and the difficulties that small- and medium-sized enterprises are facing, the Chinese government may need to adopt even more fiscal and monetary stimulus.
But implementing this policy will involve a series of challenges. The most acute obstacle for Beijing will be how to balance Covid-19 pandemic control with economic growth.
While the People’s Bank of China continues to loosen its monetary policy, the Federal Reserve is going in the opposite direction.
The narrowing of China-US benchmark interest rates has led to an increase in capital outflows and yuan depreciation despite Beijing’s large current account surplus.
China needs to keep a watchful eye on the yuan and cross-border capital flows. But a flexible exchange rate and a certain amount of capital controls should be enough for the central bank to maintain the independence of monetary policy and ensure financial stability.
Inflation could be another problem with China’s high PPI. But due to weak consumption and investment demand, PPI inflation has not yet translated to CPI inflation.
Due to the Ukraine war and tightening sanctions on Russian oil and gas, energy and food prices might increase further. As the largest trading nation in the world, China’s manufacturing products are highly dependent on imported parts and components.
Higher prices in the United States and other advanced countries will pass through into China’s price indexes. So, China may need to learn to live with a higher inflation rate. After all, the top priority for the government is to bring an end to the gradual but steady decline of GDP growth.
Despite facing many pandemic-related setbacks in early 2022, China should be able to do better in the second half. Importantly, China’s long-term growth perspective is still bright.
Yu Yongding is a senior fellow at the Chinese Academy of Social Sciences and a former member of the Monetary Policy Committee of the People’s Bank of China.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of China Factor.