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Challenges and Changes to the Chinese Economy

Feb 18, 2019
  • Xu Hongcai

    Deputy Director, Economic Policy Commission


In the past year, a drastic change has occurred. The growth momentum of the global economy was strong in the first half of 2018, but it slowed down in the second half of the year, and the slowdown will continue over the next two years. The IMF cut its forecast for world economic growth in 2019 to 3.5%, compared with 3.7% last year. The USA’s economy is expected to grow 2.5% this year, compared with 2.9% last year. At the same time, the IMF also lowered the expected growth in Europe, Japan, and developing countries. Looking back to 2018, “black swan” events took place frequently worldwide. The economic policies of the major economies changed a lot. The international oil price, the stock market, and foreign exchange market quaked dramatically. Global foreign direct investment was shrinking. Global trade growth is slowing down.

China's economy as a whole has remained stable. There are several economic indicators: first, the GDP exceeded ¥90 trillion for the first time; second, the per capita income reached $10,000 for the first time; third, the volume of foreign trade exceeded ¥30 trillion yuan for the first time; fourth, the foreign exchange reserves remained above $3 trillion. These achievements are indeed hard-won. Last year, China's GDP grew by 6.6%, but it also showed a declining trend quarter by quarter. Even so, China has still contributed about 30% of the world's new GDP growth and remained a veritable engine of world economic growth.

China's economy has made steady progress and shown signs of improvement in five aspects. First, the economic growth rate was within a reasonable range. It is expected that China's GDP will grow by 6.3% this year and by more than 6.0% in 2020. China is likely to complete the building of a well-off society in all respects by 2020. Second, inflation was stable. The consumer price index (CPI) grew by an average of 2.1% in 2018, and urban and rural residents’ income growth was roughly in line with economic growth. Third, the employment situation was good, with 13 million urban jobs created for six consecutive years. Fourth, the international balance of payments has reached basic equilibrium. The trade surplus has narrowed, and there has been no large-scale capital outflow. Both FDI and outward direct investment have maintained steady growth, and the RMB exchange rate has remained relatively stable at a reasonable and balanced level. Fifth, we made positive progress in supply-side structural reform, improved the economic structure and raised the quality and efficiency of development. The investment structure was optimized, with investment in environmental protection and agriculture increasing by 43.0% and 15.4% respectively in 2018. The added value of the tertiary industry accounted for 52.2% of GDP and contributed 59.7% to GDP growth. Consumption as the main driving force of economic growth was consolidated, and the final consumption expenditure contributed 76.2% to GDP, 18.6 percentage points higher than that in the previous year. China made solid progress in pursuing green development, and energy consumption per ¥10,000 of GDP decreased by 3.1% over the previous year.

However, China's economy also faces new challenges. World economic growth will slow down in the coming years, and the economic policies of the United States, Europe, and other major economies are full of uncertainties. With the prevalence of protectionism, populism, and unilateralism, the multilateral trading system with the WTO as the core and the global governance are facing unprecedented challenges. In recent years, China's foreign trade surplus has narrowed year by year. In 2018, China's foreign trade surplus hit a record low with only $350 billion and will keep declining in the future. Meanwhile, the principal contradiction in Chinese society has been transformed into one between the people's ever-growing need for a better life and unbalanced and inadequate development. In recent years, with the increase in labor costs and the improvement of environmental protection standards, some low-end manufacturing industries have begun to migrate to neighboring countries. Investment growth is also weak, and it is difficult to keep relying on expanding investment to drive economic growth. At the same time, the growth of household consumption is not strong. High housing prices in first-tier cities have squeezed consumer spending. The growth of traditional consumption, such as in housing and automobiles, was weak, while the growth of emerging consumption, such as tourism, culture, information, pensions, health, and sports consumption, accelerated, but their share on the whole was low. In recent years, enterprises have significantly increased their investment in research and development. However, it still takes time to cultivate new drivers of economic development. The manufacturing industry is large but not strong, and the overall level of science and technology is still low. In the past few years, although we have kept the bottom line of no systemic financial risks and generally maintained financial stability, some local financial risks have inevitably emerged, such as the collapse of P2P platforms, default of corporate bonds, and volatility of the stock market, which have had a negative impact on the development of the real economy.

At the beginning of the new year, we feel the uncertainty from the outside world while starting a new round of reform and innovation. There are favorable conditions: first, China has maintained political stability, and policy continuity and flexibility. Second, domestic demand is relatively stable and the market is huge. With the growth of per capita income, people's demand for diversified consumption increases. Third, the role of innovation in driving economic growth is rising, and technological progress and industrial restructuring are gaining momentum. Fourth, consumption has become the main driving force for economic growth. Fifth, the dividends of a new round of deepening reform and opening up will be seen. China’s policymakers are making new adjustments.

The first is a proactive fiscal policy. China will cut taxes and fees, including corporate income tax and value-added tax, especially reducing the operating costs of small businesses so that they can carry out their business more easily. At the same time, China will create a sound business environment and reduce institutional costs. By the end of 2018, China's import tariffs had been cut from 9.8% to 7.5% and will be lowered in the future. China will increase investment in infrastructure to promote connectivity and the free flow of production factors. So, there is a need to expand the issuance of special local government bonds from ¥1.6 trillion to ¥2 trillion. The fiscal deficit is likely to rise to 3% from 2.6% last year. Second, China will adopt a prudent monetary policy with an appropriate level of money supply, preventing violent fluctuations in the financial market, maintaining reasonable and sufficient liquidity, dredging channels for conducting monetary policy, developing multi-tiered capital markets, and preventing and defusing major financial risks. Third, structural reform policies will focus on building and nurturing new system mechanisms. In June 2018, China revised the negative list of market access for foreign-invested enterprises. In December, it released the negative list of market access for domestic enterprises (2018 version). It plans to implement the “one list nationwide” management model in March 2019 and fully implement the management model of pre-establishment national treatment and negative list. Everything that the market can do should be left to the market, and the decisive role of the market in resource allocation should be brought into full play. Meanwhile, the role of the government should be managed well to make up for market failure.

In 2019, China will accelerate reform in key areas, especially in the reform of state-owned assets management and state-owned enterprises. China will focus on maintaining and increasing the value of state-owned assets. It will expand the scope for mixed-ownership reform, break the monopoly and encourage competition. Private capital will gradually play a leading role.

Meanwhile, China will establish a modern fiscal and tax system, straighten out the relationship between the government and the market, and reduce the cost of government operations. In financial reform, China will improve the efficiency of financial services for the real economy. Large financial institutions should realize strategic transformation, strengthen internal risk control and improve risk pricing ability, so as to adapt to the trend of comprehensive operation of financial institutions and expand financial openness. China will encourage the development of private banks and other small- and medium-sized financial institutions.

In my opinion, the most promising place for China's economic development in the next decade is the rural-urban area. China is gradually establishing a mechanism for the two-way and orderly flow of production factors between urban and rural areas, promoting integrated development between urban and rural areas, rural revitalization, and the construction of urban infrastructure. In particular, China should deepen the reform of the land system, increase the application of new technology and improve the rural market system, promote the transformation of agricultural development from a small-scale peasant economy based on families to a modernized agriculture, and promote the development of urbanization by fostering new industries and creating new employment opportunities. With a large number of farmers turned into citizens, the consumption growth of Chinese residents has great potential.

Looking into 2019, the difficulties in the first quarter may be large, but China's economy is projected to stabilize in the second half of the year. It is expected that the annual economic growth rate will remain between 6.0% and 6.5%, and the CPI rise will be around 2.2%. 13 million new urban jobs will be created. Investment in fixed assets is expected to grow by about 6.5%. The growth of imports and exports will slow down, and the trade surplus will narrow to about $300 billion. However, the trade structure tends to be optimized, and the competitiveness of foreign trade enterprises will be enhanced. China will adopt a more proactive fiscal policy, cutting taxes and fees by about ¥2 trillion and expanding infrastructure investment by the same amount. Monetary policy will be slightly loose at the margin. M2, the broad money, will grow by about 9.0%. RMB loans will grow by about 10%, and the nominal interest rate will remain unchanged. By the end of 2019, the dollar-RMB exchange rate will remain within 7.0. In general, China's economy will continue to grow steadily in the future.

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