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Business News/ Opinion / Columns/  China’s economy is plainly staring at a flickery future
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China’s economy is plainly staring at a flickery future

It faces slow growth and rising inflation while its forex reserves and current account surplus shrink

The People’s Bank of China, after having held the line for much of the early covid period, has begun to ease monetary policy from around April this year (Photo: Bloomberg)Premium
The People’s Bank of China, after having held the line for much of the early covid period, has begun to ease monetary policy from around April this year (Photo: Bloomberg)

The global economic system is going through an unprecedented period. Developed market central banks have begun to raise interest rates sharply and have initiated quantitative tightening at the same time. The US Federal Reserve’s balance sheet that had expanded rapidly from about $4 trillion to about $9 trillion in response to the covid pandemic has gradually begun to shrink.

In contrast, the People’s Bank of China (PBoC), after having held the line for much of the early covid period, has begun to ease monetary policy from around April this year. M2, the broad measure of money supply, is expanding at a rate of about 12% year-on-year in China and is now greater than credit growth, which is at about 10% year-on-year. Economic growth, meanwhile, has not responded in the wake of continuing lockdowns. In economics speak, these are early signs that China’s money supply has begun to “push on a string" and further stimulus may have to come from fiscal policy.

The PBoC balance sheet size is about 38 trillion Chinese Yuan (CNY) or about $5.6 trillion (62% of the size of the US Fed’s). The PBoC balance sheet, which has been on steady expansion through the years, appears to have qualitatively shifted its approach in 2016. Until then, the expansion was in lock-step growth with China’s current account and its growth in foreign exchange reserves. Since 2016, the PBoC balance sheet has grown by increasing lending to the country’s banking system. China’s foreign exchange reserves peaked at about $4 trillion then and have declined by nearly a trillion dollars. At the same time, Chinese current account surplus has declined from an average of about 3-4% of gross domestic product (GDP) before 2016 to less than 2% now, so structurally it seems likely that its pace of currency reserve accumulation will continue to drop.

In other words, China’s economy is slowly becoming less international and more domestic. As that happens, China’s policymakers are beginning to find that their tools for domestic macro-economic management, both monetary and fiscal, are not sufficiently diverse and well tested. China’s go-to policy for domestic expansion has been to stimulate its real-estate sector. True to form, 33 new measures were introduced in the summer to invigorate the sector. However, these measures contradict one pillar of ‘Xi Xinping thought’, which is to deleverage and clean up the real-estate sector, an activity that has been ongoing for some time. Therefore, despite these stimulus measures, China’s residential sector declined 28% year-on-year in July. Meanwhile, Chinese retail sales have slowed to about 3% for the first half of the year, which apart from the directly covid-affected quarters of 2021 and 2022, is the slowest it has been for 30 years. At the same time, even as economic growth slows, inflation in China is gradually increasing and clocked 2.7% in July. The CNY has declined by about 10% from the beginning of this year and this is one channel through which inflation is being imported into the country.

It seems rather likely that China will push both monetary and fiscal easing in an attempt to get out of the economic quagmire that it finds itself in. The country will be doing so at a moment when inflationary pressures are not benign. Before the pandemic, China has generally been careful to keep its fiscal balance in a narrow range as a proportion of GDP. The pandemic, its ageing population and its trade war with the US have begun to strain China’s ability to use fiscal policy too aggressively. Local governments have faced revenue shortfalls, requiring an increased federal transfer. The sale of land-use rights is a plug, but this has been disappointing because of simultaneous tightening of regulations in the real estate sector. In a flailing attempt, increased property tax increases have been proposed in a few jurisdictions, but this medicine may be worse than the disease and has therefore been postponed.

China has already put in place tax cuts for corporates and individuals. Even though China categorically denies that there will be “overborrowing from the future", it seems possible that China may be forced to follow the US of 2020 by doing income transfers in a desperate attempt to stimulate retail spending. At the very least, this will have to be done in some form to ensure that property buyers regain confidence in a system that now appears to be completely broken.

For the rest of the world, this adds another element to the unprecedented global situation. Developed markets and some emerging markets (including India) are tightening policy at the same time as China is easing. If much of that easing is transmitted through a lower currency value, then it will have the de facto effect of a competitive devaluation by China, and other exporting economies will suffer as a consequence. If China holds its currency relatively stable from here, then with untested domestic transmission mechanisms, it risks stagflation.

Slow growth, a shrinking current account surplus and declining foreign exchange reserves amid increasing inflation in China is not a scenario that the rest of the world has been accustomed to—for at least three decades now. The competence of Chinese macro-economic management is being tested. Early signs suggest, surprisingly, that it is running up against irreconcilable contradictions and is coming up short.

P.S. “The flame that burns twice as bright, burns half as long," said Chinese philosopher Lao Tzu.

Narayan Ramachandran is chairman, InKlude Labs. Read Narayan’s Mint columns at

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Published: 29 Aug 2022, 10:08 PM IST
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