The spectacular growth of China’s economic and military power generated ripples of anxiety across the world, necessitating statements from the Chinese leadership affirming the country’s commitment to a peaceful path of development. While some recent Chinese actions, particularly those concerning the South China Sea territorial dispute, as well as the country’s aggressive drive to expand its sphere of strategic and economic influence, do not allay the fears about China’s stance, the narrative on China has also shifted. There are growing anxieties about the sustainability of the Chinese development model and fears of a precipitous economic decline that would almost certainly push an already enfeebled world economy into a recession.
The economic crisis of 2008 and the collapse of the “Washington Consensus”, provided to the Chinese leadership a vindication of its model of economic development. This model relied majorly on state intervention and oversight in the management of the economy to avoid the cycles of high unemployment and low growth that western capitalism seemed to be periodically afflicted with. But the 2008 global crisis sharply underscored the fact that the investment and export-led growth model which China had so successfully followed would yield diminishing returns in the future. The Chinese economy, therefore, needed to be significantly restructured or “rebalanced” towards domestic consumption and services for sustainable future growth.
While the Chinese leadership has been cognisant of the immensity of the task of restructuring a giant economy, they have also been daunted by the economic disruption and pain this would entail. Soon after taking over as president, Xi Jinping had declared his commitment to comprehensive economic reform and a “decisive role” for the markets to rebalance the economy. However, growth has continued to be driven by debt-financed investment — the debt to GDP ratio has risen from around 150 per cent before 2008 to over 250 per cent currently, making China the highest leveraged large economy in the world. Data released by the Bank for International Settlements reveal that Chinese companies are saddled with debts of $18 trillion (around 170 per cent of the country’s GDP) loaned mainly from state-owned banks. Although officially, only two per cent of the loans are non-performing, the IMF’s estimates that around 15 per cent of the loans are stressed. There is thus a clear and escalating danger of a “full-blown banking crisis” if these concerns are not quickly mitigated. However, there is a strong reluctance to deviating from a path that has delivered stable rates of growth.
Although aware that an economy as complex and globally integrated as China cannot continue to be primarily managed through the levers of the state, Chinese policymakers have been deeply uncomfortable towards ceding economic control to market forces and accepting the increased volatility that this implies. Such apprehensions were exacerbated by the turmoil in the stock markets and the exchange rate volatility witnessed in China in August 2015, which rattled the Chinese leadership and raised serious doubts about the competence of Chinese economic management. Such risks appear unacceptable to the party leadership and the Chinese economy remains trapped in the uncertain terrain between state control and the market.
Declining economic muscle has not deterred Xi from aggressively pursuing his hugely ambitious One Belt One Road(OBOR) initiative, which aims to significantly augment Chinese strategic and economic influence across the globe through the creation of a vast network of infrastructure projects. The primary rationale of these projects is strategic, not economic, and the large external commitments that they potentially entail, conservatively estimated at $1trillion, sans escalation costs, pose an added risk to an already overextended economy.
Outbound investments by Chinese companies has been rising rapidly — they reached $150 billion in the first 10 months of 2016, surpassing $121 billion in the previous year. Rising capital outflows have put pressure on the yuan which has depreciated by almost six per cent this year against an appreciating dollar despite aggressive official interventions in the currency market. To stem the drain of foreign exchange reserves, which have declined by 25 per cent this year, and ease the downward pressure on the yuan, the government has imposed capital controls on outbound flows revealing rising internal anxieties about capital flight.
The dashboard on the state of the Chinese economy is flashing red signals on several fronts. However, Xi seems mainly focussed on consolidating his hold over the party. The anti-corruption drive has been a useful instrument in dealing with political opponents, but it has also transgressed an implicit compact between the party and the government — that the latter would not be unduly prying on the financial dealings of party members. Given that corruption is deeply entrenched, the drive has generated fear and resentment in the party ranks.
Politically risky reforms are, therefore, on the backburner, at least till the party plenum next year when Xi comes up for re-election. Till such time, stable growth is the prime goal no matter how it is achieved. Minxin Pei, a doyen among Sinologists, has termed the situation in China as a “state of trapped transition” — a state of partial economic and political reform in which the party leadership is unable to deviate from a path of unsustainable development path for fear of losing economic and political control.
Analysts are divided on the future of the Chinese economy, with those predicting a smooth landing presently in a minority. China has, several times in the past, proved the Cassandras wrong. But this time a turbulent transition seems unavoidable.