Top Five Challenges Facing the Chinese Economy

The Chinese economic prowess is second to none. They have certainly pulled off an economic miracle since Mao Zedong began unleashing his tough policies on the people. The transformation was painful. However, as a result, China has become a global economic behemoth, a power to be feared.

It is the second largest economy in the world after the United States. It is also the third largest importer in the world after United States and Eurozone. It is also the largest consumer of commodities like oil, cement, iron and steel etc.

These credentials make it abundantly clear that the Chinese economy plays a pivotal role in global trade and commerce. In the past one year, this economy has faced a lot of flak. The stock markets have gone to all time lows. The property market is said to be in a bubble and the Chinese economy seems to be crumbling under its own weight.

In this article, we will look at the major issues that are plaguing the Chinese economy.

1. Falling Growth Rate:

   Chinese economic growth rate has been unprecedented. The economy has been growing over 10% per annum for a couple of decades now. However, since Chinese economy is centrally planned, this growth rate was planned by the government too.

   Hence, this growth rate was largely fuelled by the very ambitious infrastructure projects that were undertaken by the government of China. However, there is a problem. The infrastructure projects also caused a lot of debt. Over the years, the economy became overburdened with this debt.

   Now since the market sentiment is negative and more debt cannot be added, the growth rate has started crumbling. The most recent statistic has shown growth rate to be close to 6.5% and this has already started causing investor panic based on fears that this number could dip even further if the Chinese are not able to find another cheaper source of funds to fuel their growth ambitions.

2. Export Driven Economy to Consumption Driven Economy:

   The Chinese economic miracle was fuelled by the United States consumption debacle. The United States has almost extensively been consuming China’s produce. China has been exporting to a lot of other nations as well. However, United States single handedly accounts for over a third of Chinese exports.

   The United States consumption has been enabled by loose interest rate policies implemented by the Fed. Zero interest rates led to a lot of money floating around. A huge chunk of this floating money ended up being spent on Chinese goods.

   After 8 years of zero interest rate policy, the rates are now set to rise. This is expected to cause a drastic drop in demand in the United States. As a result, Chinese exports will also suffer. Add to this the fact that the economy is already slowing down and we may have a deflationary scenario underway.

   China’s big challenge is to sustain its economic prowess on a domestic economy. Instead of selling to other countries, Chinese businesses now have to sell to each other, if the miracle has to be sustained.

3. Manufacturing and Banking Viability:

   The Chinese government central planning has led to a lot of mal investments. This is particularly true in the manufacturing sector. Since the money was loaned out by state banks, the banking system is also reeling under the effects of this problem. The government is currently managing these non performing assets. However, these assets could cause mayhem in the Chinese banking sector. Also, a lot of money has been lent out to developers who have built ghost (uninhabited) towns with it! This money is also unlikely to be recovered. The Chinese banking system could come under a lot of pressure as these NPA’s become certain. The spillover effects of this downturn could be felt in the stock markets as well as across the world.

4. Tax Revenues and Expenses:

   A falling GDP also means falling tax revenues for the Chinese government. This becomes a huge problem when one adds the fact that China is a communist country. A centralized economy is based on funds being disbursed from the center. Falling tax revenues and rising expenditures have created shortfalls which need to be filled by borrowing money. Given the debt trap that China may soon find itself in, borrowing is not really a viable option. China will have to figure out other ways to collect more tax or else it may have to cut spending even further causing the GDP to go into freefall!

5. Regional Imbalances: Coastal to Internal

   The economic boom has led to widespread development all across China’s coastal periphery. This is obvious given the fact that Chinese growth story was fuelled by exports. Now, since domestic consumption is the key factor, China will have to focus on its severely underdeveloped internal areas. Interior China is still a third world country with low standards of living. This can be viewed as a challenge because sustaining high Chinese growth rates with such poor infrastructure will be difficult to say the least. Also, it can be viewed as an opportunity since developing the internal areas will help give a fillip to the Chinese GDP for several years to come. Thus, there is enough fuel for the Chinese growth juggernaut to continue its run for another year or so.