The overriding consensus is that China is investing at an unsustainably fast pace. The symptoms include empty malls, shoddily built railways and ghost cities. This investment-led growth model can’t continue indefinitely. The debate for most analysts is not if China will slow, but when and by how much.
As a result, I was surprised by the IMF’s latest forecast that shows growth remaining quite robust over the next five years. China’s economy is expected to grow by over 9% annually in 2012-16, as shown below.
Figure 1: The IMF sees real GDP growing at an average annual rate of 9.4% over the next five years
At the same time, the IMF envisages investment falling only slightly as a share of GDP to 46.2% in 2016 from an estimated peak of 48.7% this year. That implies investment will continue to grow strongly (at an average annual rate of roughly 8%) through 2016, even though most analysts agree that China is already over-investing, such that capital is being directed toward activities (eg. ‘white elephant’ construction projects) that are doing nothing to enhance the country’s productive capacity and long-term growth potential.
Figure 2: China’s investment to GDP ratio is far and away the highest among the big EMs, highlighting the economy’s reliance on investment-led growth
Figure 3: The IMF does not expect any significant shift from the investment-led growth model over the next five years
I can appreciate the challenges the IMF faces in developing its forecasts. In the same way that it was hard to put a date on when the US housing bubble would pop, it’s also hard to time China’s slowdown and its severity. Nevertheless, a forecast of steady, above-9% GDP growth through 2016 appears overly rosy, especially considering a recent IMF report where the institution acknowledges the risk that over-investment poses to sustainable economic growth.
“[C]ontinued high investment could, down the road and absent sufficient progress in rebalancing, create excess capacity, given uncertain demand prospects in advanced economies, thus risking a hard landing that reverberates beyond China.” (See IMF Country Report, July 2011, pages 5-6) In effect, the IMF appears close to contradicting itself. Very little movement is expected in the investment-to-GDP ratio over the next five years, meaning the IMF does not expect any significant rebalancing toward consumption. At the same time, the institution foresees growth holding steady over the period.
What is interesting is that even the 12th draft of China’s five year plan for 2011-15 stands in sharp contrast to the IMF forecast. The plan foresees GDP growth slowing to an average of 7% annually and targets a rise in domestic consumption.
What Do Analysts Think?
Most China watchers believe some sort of correction is unavoidable, although they do not necessarily see a slowdown as imminent. A number seem to think the breaking point could come soon after 2013 – a year of transition in the Communist Party leadership.
Patrick Chovanec – an economics professor at Tsinghua University – sees a slowdown as inevitable. “China will have a correction, China needs a correction.” He notes, “There is a tug-of-war between those who say keep lending and let growth continue, versus those who are more concerned about inflation and want to rein it in.” This sounds like the typical battle of words before a bubble pops.
Michael Pettis – a Wall Street veteran and finance professor at Peking University – also sees a slowdown in the offing, but not this year or next: “[A]s long as the Chinese government retains its capacity to raise debt we are not going to see a sharp slowdown in economic growth – at least until 2013. Any indication that the economy is slowing too quickly will be met with a relaxation of credit controls, and the concomitant rise in investment will spur growth. “
Nouriel Roubini – the New York-based economist who correctly predicted the popping of the US housing bubble – is one of the brave souls to put a date (at least sort of) on China’s slowdown. He sees the bubble bursting after 2013, which is when the change in political leadership is due. “Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown.”