Economic Outlook on China

In the long run, we expect China to further liberalize its economy by cutting tariffs and opening up the services and finance sectors to foreigners, as well as to reduce its presence in state-owned banks and enterprises. This continued liberalization of the economy, coupled with high levels of domestic savings and steady foreign direct investment and strong exports, will keep growth in the 8-9% range. The service sector is expected to be the most dynamic part of the economy, as the result of liberalized markets, increased infrastructure and a shift in the composition of the labor force. Foreign direct investment continues to flow in and the current account and trade balance continue to post surpluses throughout the forecast horizon.

China’s economic growth is dependent on its ability to sustain a high rate of capital accumulation.

Three major factors suggest that investment demand will accelerate further in the years to come. First, China’s infrastructure (energy, transport, telecommunication and water supply) is inadequate. For instance, energy production chronically lags behind total industrial output growth. In addition, international infrastructure statistics place China near the bottom of the world ranking. Second, the need to upgrade and augment the capital stock will become more pressing as Chinese companies increasingly face fierce competition in both domestic and foreign markets. Deregulation of capital depreciation rates (currently very low) will also help as Chinese companies will have an incentive to use new equipment. Third, the underlying demand for residential investment is very strong, as China suffers a huge “deficit” in residential housing. Hence, the massive demand for housing is projected to generate a boom in residential investment.

One question is whether China will be able to generate sufficient savings to meet its massive investment demand. We expect that this will be the case. So far, China has financed its investment mainly by domestic savings, with foreign capital inflows serving as a residual to fill the investment gap. While the deregulation of the economy and the restructuring of the state-owned enterprise sector are underway, the central government will continue to bear the brunt of subsidizing state companies, food prices, and a wide variety of public utilities for a few more years to come. Hence household savings will play an important role in fueling investment. Statistics show that a typical Chinese household saves as much as 35-45% of its disposable income.

Another long-term challenge for China is the narrowing of economic disparities between the coastal regions and the central and western provinces. Despite Beijing’s regional development strategy, aimed at reducing growing economic inequality across the country, key coordination issues that need to be addressed include interregional cooperation, redistribution of resources from richer to poorer provinces, and closer links with external countries to encourage the inflow of foreign capital and technology.