The 19th Party Congress of the Communist Party of China (CPC) begins on 18 October. A large part of the CPC’s existing leadership is expected to retire this time. China might also get a new central bank governor by early next year, reported Reuters. In addition to political and strategic questions, the new CPC leadership would also have to confront legacy issues arising from years of imbalanced economic growth. China has been trying to make a transition from an economy focused on exports and investments to domestic consumption.
China’s growth as an economic super-power was accompanied by a phenomenal rise in share of investment expenditure in GDP. Since 2004, investment expenditure share has exceeded that of household consumption expenditure in the economy. Although the gap started narrowing from 2010 onward, it was still 5 percentage points in 2016. The post-2000 period has also seen an increase in household savings rate in China, which is the highest among major economies in the world.
The reasons behind high savings rate among Chinese households are said to be complex. They are partly a response to inadequate social safety nets (like pensions, medical insurance) and partly a response to increasing uncertainty and unemployment risks which worsened in 1990s amid reforms related to state-owned enterprises.
The IMF has advised the Chinese government to increase spending on health, education, and social security while reducing spending on infrastructure. Such measures, according to the fund would reduce the precautionary urge to save more.
To be sure, rising income inequality has also played a big role in subdued growth of household consumption expenditure in China. If the rich are cornering a larger part of the fruits of growth than the poor, it is only natural that savings rather than consumption would grow at a faster face.
China’s regressive tax base has not helped matters. More than half of China’s tax collections comprise of indirect taxes. Rich and poor have to pay the same amount of indirect taxes, unlike a progressive income tax which rises with income levels.
A savings glut has been accompanied by unnecessary debt-driven investment in important sectors of the economy. Excess capacity has been increasing in sectors such as aluminium and steel. Credit to private non-financial sector as a percentage of GDP in China is at way above what it was in countries where economic crisis erupted. The IMF in its Global Financial Stability Report highlighted the dangerously high levels of Chinese debt.
Much of the dubious debt creation, i.e. where asset quality might not be sound, has been financed by smaller banks and non-bank financial institutions. These institutions often escape the more stringent regulations, meant for big banks. Thus, excessive regulation, instead of mitigating the problem of unmindful lending and borrowing, has only exacerbated problems with financial institutions and borrowers indulging in regulatory arbitrage.
It remains to be seen how the regulators tackle the debt problem. As of now, the response of the authorities has been to increase regulation, sometimes on banks, sometimes on property markets, etc. On the one hand regulators are trying to clamp down on irresponsible lending to SoEs and big corporates, on the other hand they are trying to encourage lending to smaller firms and those in agricultural sector. Therefore, the People’s Bank of China (PBoC) recently relaxed reserve requirements for select banks.
] Whether such micro-managing will yield results or will it lead to further shadow banking practices remains to be seen.
It would be interesting to see if policymakers announce any specific plan to tackle the problem of excessive savings, just like it has done for the problem of excess capacity.
This is the first of a two-part data series on the economic challenges facing China ahead of the 19th party congress of the ruling Chinese Communist Party