The Chinese Economy is Transforming

A new Chinese economy has been a looming threat over the past few years. It has slowly drifted away towards the accelerated, variable pace of an emerging market economy to move towards a mature service based economy centered around consumption. In the World Bank's China Economic Update for December 2018. The economic data in the report shows how the change is progressing and how its reacting to the current trade dispute with the United States.

The most troubling aspect of the shift is the slowing of Chinese GDP despite the gradual pace. The Chinese government already projected lower numbers for the 2019 year, but the World Bank report shows that this is no sudden adjustment. "GDP growth slowed to 6.5 year-over-year in the third quarter from 6.8 percent year-over-year in the first half of 2018 and 6.9 percent in 2017," as mentioned in the report.

An interesting aspect of the slowing GDP is that the deceleration is mostly caused by lower exports. Net exports weighed on GDP growth accounting for -0.7 percent of GDP. Net exports, which is usually a positive for China, was dragged down by a current account deficit of $12.8 billion (0.1 percent of GDP). For context, China's current account balance was 2.8 percent of GDP in 2015 and is projected to be even lower in 2020 at -0.4 percent of GDP. These projections are mostly based on the premise that imports (outflows) will stay strong as exports (inflows) will weaken.

That trend is exactly what happened in late 2018. According to the report, "Net capital inflows (including errors and omissions) totaled $79 billion in the first half of this year and turned into outflows of $19 billion in the third quarter." The decrease in inflows was caused by foreign investors abandoning the Chinese stock market and reducing their holdings of Chines bonds. Interestingly enough, this coincided with the trade war with the U.S. which results in an increase of the current accounts strictly between the two countries.

All the macroeconomic pressure, has resulted in pressure on the stock market. The MSCI China Index declined 13.7 percent in the second half of 2018 and trading of the Renminbi has been volatile and inflationary. The result is that the People's Bank of China has chosen to be looser in its monetary policy by loosening reserve requirement, and the Chinese government has sought to be more expansionary "since July by means of tax cuts and higher local government investment."

The signs continue to point towards a reformed Chinese economy. Gross fixed capital investment and net exports threaten to become smaller components of GDP growth as final consumption becomes a larger component. In 2015, final consumption was 59.4 percent of GDP growth and has grown to make up 69.2 percent of GDP growth if projections are accurate. The shifting of the world's largest economy to become weaker and more consumption based will affect the global economy in a significant way.


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