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21 January 2016, Gateway House

Interpreting China’s economic challenge

Low GDP growth numbers and the tumbling Shanghai Composite are not enough to judge China’s economic management strategy. It is the long-term, structural, and geoeconomic challenges that will determine the country’s economic future

Former Director of Research

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Critics of China have moved into high gear after the country’s low GDP growth numbers were released on January 19 and the Shanghai Composite continued to tumble. Their concerns about economic mismanagement are enhanced by the opaque manner in which China’s economy functions; data is hard to get, and when information is available it does not add up in any meaningful way for assessing the country’s political and economic decision-making.

But based on what is publicly available, two things are clear: one, China’s economy should not be narrowly judged only on the basis of its stock market indices and GDP numbers. Two, a meaningful assessment of China’s future depends on an accurate analysis of its long-term, structural, and geoeconomic challenges. Anything else will be a misinterpretation of the country’s economic management challenges.

In 2015, China’s $10.3 trillion economy achieved 6.9% annual growth—this is not an easy task when the world is still recovering from the trans-Atlantic financial crisis.[i] Even if it is the country’s slowest growth in 20 years, in the process China has become the world’s second largest economy (in nominal terms). And even the most pessimistic estimate of a 4% growth rate means that China is adding $360 billion (or the equivalent of the economy of South Africa) to its GDP every year.

Similarly, stock market indices are only one indicator of the health of the economy.  A 42% drop in the Shanghai Composite—from a peak of 5166.35 (on 11 June 2015) to the current level of 2966.66 (on 18 January 2016)—is clearly substantial.[ii] But, for now, the index is still higher than what it was between 2011 and 2015.

More importantly, the traders on these exchanges are increasingly retail investors—a new class of investors likely to be more impulsive than institutional investors. Foreign investment into the equity markets is limited and controlled through well-managed programmes such as the Qualified Financial Institution Investors (QFII) and the Renminbi QFII. Even experiments such as the Shanghai-Hong Kong Stock Connect programme, that enables residents of mainland China to invest in the Hong Kong market and vice versa, limits investments to $40 billion and $48 billion, respectively.[iii]

Therefore, market volatility cannot be attributed to mismanagement of the economy.

What will indeed impact China’s economic trajectory are the threats emanating from the crystallisation of mega-trade agreements between developed countries, internal hurdles to becoming a consumption-led economy, and the lack of promising investment options for the country’s reserves.

The Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment agreement (TTIP) are designed to move geoeconomic heft away from China. Foreign-owned enterprises are responsible for 50% of trade in China, and 40% of China’s exports go to North America and Europe.[iv] China will lose both foreign direct investment and export revenue when the focus of multinationals shifts to TPP/TTIP member countries. The 7% drop in trade in 2015 is a matter of concern for China and the devaluation of the renminbi is an impulsive reaction.

This partly explains why China is pushing for the APEC-led Free-Trade Agreement of the Asia-Pacific. China will be a member, and this will help the country to arrest the shift of trade away from its own shores. It also explains why China is pushing hard for a consensus on the Regional Comprehensive Economic Partnership (RCEP) that includes ASEAN countries along with India, Australia, New Zealand, South Korea, and Japan. The RCEP can help diversify its export market, and restrain ASEAN or India from becoming more potent alternatives to China in the global economy.

The Chinese government is cognisant of the external threats. Its five-year plans envisioning a qualitative shift towards a consumption-led economy is a planned response. But this shift is not easy to make—it takes time to create a society of entrepreneurs and drive consumption. India, for example, has a large segment of small and medium enterprises and yet often fails to support them effectively. For China, reconfiguring government support away from state-owned enterprises, utilising the excess industrial capacity for the domestic economy, diverting labour from manufacturing to services, and re-engineering the real estate-driven revenue model for local governments are huge internal challenges.

Their strategy is working to some extent. Services grew by 8.3% in 2015 and already account for 50% of GDP.[v] Consumption is becoming the main driver of economic growth,  already contributing to 66% of GDP.

There is also the question of how to optimally use reserves. China has  invested $1.2 trillion of its reserves in U.S[vi] treasury securities that should ideally be invested in assets that are safer and high yielding. But better options are not available anywhere else in the world.

It is in this context that China is experimenting with the Asian Infrastructure Investment Bank, the Silk Road Fund, and the BRICS New Development Bank. These formal, transparent, market-based institutions are experiments to channelise their reserves into assets that provide both financial and diplomatic returns. Global investors looking for transparency in Chinese economic thinking must welcome these new initiatives. So should India, which needs capital for infrastructure investments and prefers a multilateral approach.

Other attempts such as the One Belt One Road initiative are similar experiments to diversify the infrastructure-focused companies, semi-skilled labour force, and investments towards developing economies in Central and South East Asia.

China could also expand its own capital markets so that it can recycle the excess global and domestic savings for its own economic growth, just as the U.S. has done for many years. But that will require further capital account liberalisation and divesting state ownership—and this economic and political challenge in the short-term may bring the very volatility that is scaring away investors today.

So while mismanagement of the Shanghai stock exchange is tarnishing China’s reputation as a market economy and requires a review, it is the macroeconomic challenges that China will have to overcome to cement its economic future.

Akshay Mathur is the Director of Research and Geoeconomics Fellow at Gateway House: Indian Council on Global Relations.

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[i] National Bureau of Statistics of China, “Press Release: China’s Economy Realized a Moderate but Stable and Sound Growth in 2015”, 19 January 2016, <>

[ii] “Shanghai Stock Exchange Composite Index”, Bloomberg Business, <>

[iii] “Shanghai Hong Kong Stock Connect”, China Stock Markets Web, <

[iv] Lombardi, Domenico and Hongying Wang (eds.), Enter the Dragon: China in the International Financial System, Centre for International Governance Innovation, Waterloo, 2015

[v] National Bureau of Statistics of China, “Press Release: China’s Economy Realized a Moderate but Stable and Sound Growth in 2015”, 19 January 2016, <>

[vi] “Major Foreign Holders of Treasury Securities”, Treasury International Capital (TIC) System Database, <>

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