China's Rebalancing: Recent Progress, Prospects and Policies
Author: Rui Mano and Jiayi Zhang1
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

Author’s E-Mail Address: rmano@imf.org, jzhang3@imf.org
Publication Date:
12 Nov 2018
eISBN:
9781484380673
Language:
English
Keywords:
WP; PPI reflation; IMF staff estimate; PPI; reflation; industry deflator; PPI rebound; infrastructure investment; China's Gini index; investment bias
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While China’s growth gathered momentum in 2017, rebalancing was uneven and decelerated along many dimensions reflecting the temporary factors behind the growth pickup. Going forward, rebalancing is expected to proceed as these temporary factors recede, but elevated income inequality and leverage will remain a challenge. The authorities are already pursuing several pro-rebalancing policies which could be expanded to support each dimension of rebalancing while reducing trade-offs between them.

Abstract

While China’s growth gathered momentum in 2017, rebalancing was uneven and decelerated along many dimensions reflecting the temporary factors behind the growth pickup. Going forward, rebalancing is expected to proceed as these temporary factors recede, but elevated income inequality and leverage will remain a challenge. The authorities are already pursuing several pro-rebalancing policies which could be expanded to support each dimension of rebalancing while reducing trade-offs between them.

1. Rebalancing the Chinese economy is critical. Economic and social rebalancing is a major priority of the Chinese authorities, viewed as necessary to achieving their long-term development goals. The 12th Five-Year Plan (2011–2015) already included core elements of rebalancing, including boosting consumption, increasing the share of services in the economy, liberalizing interest rates, and opening the capital account (Lardy and Borst 2013).

2. This paper uses the 4-dimensional rebalancing framework of Zhang (2016) to assess economic developments in 2017. The four dimensions considered are (i) external (external to domestic demand), (ii) internal (investment to consumption, industry to services and less credit-intensive growth), (iii) environmental (reduce pollution), and (iv) distributional (reduce inequality). Each dimension in turn includes a set of summary indicators.

uA01fig01

Rebalancing slowed in 2017

(Green=substantial progress; yellow=some progress; red=lack of progress)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: IMF staff estimates.Note: Green = significant progress; yellow = moderate progress; red = reversal of rebalancing. See Appendix A.

A. Developments and drivers in each dimension of rebalancing

3. Rebalancing decelerated in 2017. Progress was uneven: external and distributional reversed, internal saw mixed progress, and environmental progressed. The same temporary factors that supported growth were behind the slowdown in rebalancing.

External Rebalancing Took a Step Back

4. Reflecting the global recovery, external demand became a major driver of Chinese real growth in 2017. The contribution of external demand to real GDP growth in 2017 was 0.6 percentage points, the largest since the Global Financial Crisis. The switch in contribution from 2016 to 2017 was 1.3 percentage points, much higher than the rise in headline real GDP growth of 0.2 percentage points. Real exports and imports both rose sizably in 2017 by 9.2 and 6.9 percent respectively (versus 0.4 and 2.5 on average in 2015–2016).

uA01fig02

Growth in domestic demand in AEs

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: IMF WEO database.

5. In nominal terms though, the current account surplus declined due to unfavorable terms-of-trade. The current account (CA) surplus declined to 1.4 percent of GDP, declining by about $25 bn in nominal terms with the trade balance declining by around $35 bn. The nominal decline in the trade balance is more than fully attributable to RMB denominated terms-of-trade (ToT), as the CA would have risen on real trade alone and exchange rate movements had a negligible impact.2 A sharp rise in the prices of raw materials is behind the decline in ToT, despite marginally higher export prices.

uA01fig03

Decomposing the yearly change in trade balance

(In USD billions)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.

Internal Rebalancing Saw Mixed Progress

6. Internal rebalancing progressed in real terms…

  • On the demand-side, investment was weak as real estate investment and manufacturing growth were sluggish. Infrastructure investment remained the anchor of fixed asset investment (FAI) and accounted for about 28 percent of total FAI in 2017, up from 23 percent in 2011 (appendix chart B1.1).

  • On the supply-side, services remained a key driver, particularly the IT sector, while the real estate sector contributed only 0.3 percentage points to real GDP growth, down from 0.5 percentage points in 2016. Other services also posted robust growth and their contribution to growth held steady in 2017 (appendix chart B1.2).

uA01fig04

Contribution share to real GDP: demand side

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC.
uA01fig05

Contribution share to real GDP: supply side

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.

7. But in nominal terms rebalancing slowed because of the strong rebound in PPI. Producer prices had been in deflationary territory for 54 quarters up to late-2015. Over 2016–17, PPI inflation witnessed a sharp turnaround, culminating in a yearly inflation of 6.3 percent in 2017. An overall rebound in Chinese aggregate demand and global trade (appendix chart B 1.2–1.5), as well as capacity cuts in steel and coal all played a role (see Ding and Mano, 2018 and Box 2.1 in IMF 2018).

  • On the demand-side, investment prices surged on the back of the PPI rebound, while CPI remained subdued depressing nominal consumption growth.

  • On the supply-side, industry posted strong nominal growth as the industry deflator grew 6.3 percent, while the deflator inflation in services was 3.2 percent.

uA01fig06

Share in nominal GDP: demand side

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.
uA01fig07

Share in nominal GDP: supply side

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC.

8. The PPI reflation also supported deleveraging. Free cash flow grew at a fast pace, both in the downstream and particularly in the upstream industries, driven both by increases in pre-tax profits due to higher prices and by a reduction in taxes and fees paid by corporates. Thus, nonfinancial private debt grew at a slower pace and credit intensity improved.3

Environmental Rebalancing Progressed

9. Environment protection has increasingly become a major goal of the authorities. Tackling pollution was elevated by President Xi to one of the “three critical battles” for the next three years in his recent address to the 19th party congress.

10. 2017 was a banner year in terms of government actions. The ratio of coal consumption in China’s total energy use fell from 67 percent to around 60 percent, while some 20 million polluting vehicles were taken off the roads. The Beijing metro area saw an intensive campaign to switch heating systems away from coal to electricity and natural gas. Its last large coal-fired power plant was shut down in March 2017. There was also a nation-wide inspection campaign to check compliance with environmental standards.

uA01fig08

Winter PM 2.5 in 74 cities

(µg/m³, bubble size proportional to city usual residence population in 2015)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Note: December excluded due to data availability. Source: CEIC and IMF staff estimates.

11. Consequently, there was a generalized improvement in air quality during the winter. Indices measuring pollution (PM 2.5) in 74 cities declined almost uniformly, particularly in densely populated cities. And the electricity intensity of growth continues to improve.

12. Many of these actions were administrative, and market-based measures will likely be needed to sustain improvements. The crack down on polluting industries is likely to continue, possibly adversely affecting growth and local labor markets, which in turn could conflict with growth and employment targets. Going forward, the focus on more systematic approaches already under consideration or implementation, such as a carbon or coal tax and environment protection tax, could help sustain the improvement.

Distributional Rebalancing Took a Step Back

13. The authorities continue to achieve remarkable progress in poverty reduction. The number of people under the national poverty line has declined from 765 million in 1980 to just less than 27 million in 2017, a rate of reduction of about 20 million per year. The target to reduce this number to zero seems within reach, but the remaining poor will be the hardest to target.

uA01fig09

Poverty rural population reducing

(Person, in millions)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: National Bureau of Statistics of China statistical yearbook, IMF staff estimation, Xinhua Net News.

14. This progress reflects several coordinated policies. The authorities have strengthened significantly policies to support the poorest, with growing disbursements under the two main social-assistance programs in China, Dibao and Wubao4, even though the number of recipients fell as incomes grew above eligibility thresholds. Other programs not specifically targeting the poor, but with large positive effects on lower income households, expanded, such as the shanty town renovation project and the rural health and pension systems.5

uA01fig10

China’s Wubao and Dibao program

(In millions of people; in RMB billions)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: Ministry of Civil Affairsof the People’s Republic of China.

15. However, inequality remains stubbornly elevated and earlier success has stalled more recently. China’s Gini index remains high and has increased marginally in 2017 to 0.467, not far below the peak level of 0.491 in 2008. The ratio of urban-to-rural incomes follows the same pattern, declining steadily up to 2012 but flattening since 2013. Median disposable income which had grown above mean disposable income, grew comparatively less in 2017 (appendix chart B1.6) Labor income to GDP fell marginally in 2017 after rising for several years.

uA01fig11

Gini index

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: China NBS, Ravallion and Chen (2007).

16. Spatial inequality increased, and convergence across provinces remaining a challenge. Several regions with lower-than-average GDP per capita were further left behind in 2017, notably in the northeast (Liaoning, Jilin and Heilongjiang) but also in the west (Qinghai, Gansu and Ningxia) and Hainan. On the other hand, most rich coastal provinces and municipalities of Beijing and Chongqing overperformed. The PPI reflation in 2017 supported the growth of several lagging provinces, and yet many could not converge to the national average (only Hebei, Henan, Xinjiang, and Shanxi exited the group of provinces struggling to converge).

uA01fig12

Diverging provinces, 2017

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Note; A province is considered a “diverging province” when its per capita GDP in 2015 and per capita GDP growth rate in 2017 are both below (“tagging”) or both above the national average [“advancing”). The rest are considered converging provinces, Source: CEIC, IMF staff estimates.

17. There are many factors behind elevated inequality in China. Rapid urbanization amid insufficient health and education coverage for migrants and structural change continue to be challenges (Jain-Chandra and others 2018). The structure of fiscal expenditure in the past has hindered greater equalization across geography and economic status. Poorer provinces rely greatly on transfers from the central government, which are still insufficient despite recent increases (Wingender, 2018). Moreover, fiscal spending does not rely much on direct transfers, resulting in unusually high savings rates of poorer households compared to other economies (Zhang and others, 2017).

uA01fig13

Deflator change: 2017 vs 2011–16

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Note: Bubble size based on nominal GDP in 2017. Red color=provinces that both grew less than the average between 2011–16 and had lower per capita GDP than the average in 2016.Source: CEIC and IMF staff estimates.

B. Putting it all together: Tradeoffs, Outlook and Policies

18. Rebalancing dimensions reinforce each other but also involve trade-offs. Going forward, rebalancing is expected to proceed as temporary factors recede, but elevated income inequality and leverage will remain a challenge. Improving the mix of policies is essential to (i) support each dimension of rebalancing while (ii) undoing trade-offs between them.

Rebalancing Dimensions Reinforce each Other but Also Involve Trade-offs

19. While rebalancing dimensions reinforce each other in general… External rebalancing requires a move away from export-intensive manufacturing facilitating internal rebalancing. Larger consumption supports the services industry and requires less of manufacturing. More consumption, less investment and manufacturing all reduce pollution. More consumption and labor-intensive services help reduce inequality. External rebalancing reduces spatial inequality as export-intensive growth primarily benefits already-rich coastal provinces.

20. …but there are trade-offs. Lowering import-intensive investment could widen the external imbalance. Reflation of PPI may facilitate deleveraging but worsens other dimensions of internal rebalancing, as in 2017. Environmental protection and reducing inequality may require initial investments and slow internal rebalancing. Environmental protection may affect already-struggling regions disproportionately, given their productive structure.

21. The synergies and tensions across rebalancing dimensions inform the outlook and policy requirements.

Favorable Outlook for Rebalancing, Though not Without Challenges

22. External rebalancing is expected to resume. Given global demand projections and China’s domestic demand developments, external demand is not projected to be a major growth driver going forward, despite expected larger demand in Advanced Economies. The current account surplus is projected to decline gradually with unfavorable terms of trade and lower real trade balances playing a role.

uA01fig15

Contribution to real GDP projections

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.

23. Internal rebalancing is also expected to progress, but deleveraging remains a challenge. Consumption and services are expected to remain growth drivers, while public investment is marginally revised down, reflecting the focus on deleveraging and increased efforts to limit local government investment. The PPI reflation will moderate and credit to GDP will rise further6 unless tightening measures result in slower credit growth to the real economy, beyond reducing intra-financial flows.

uA01fig16

PPI-CPI differential

(In percent)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.
uA01fig17

Total non-financial sector private debt

(In percent of GDP)

Citation: IMF Working Papers 2018, 243; 10.5089/9781484380673.001.A001

Source: CEIC and IMF staff estimates.

24. Environmental rebalancing is set to continue. Environmental protection will continue to be a major policy initiative, confirmed by the recent government reorganization which increased the scope of action of the Ministry of Environment. More investments are needed to bring the energy production mix and water/sewage systems to greener levels. Such activities will remain supportive of investment in the medium-term and slow the consumption-investment rebalancing. Currently planned market-based mechanisms like environment protection taxes and carbon emissions trading should be implemented swiftly to sustain improvements.

25. Distributional rebalancing will remain a challenge. Demographics, urbanization and structural change in the economy are projected to keep income inequality elevated (Jain-Chandra and others 2017). Moreover, environmental rebalancing could put further strain on the heavy-industrialized but already struggling regions in the Northeast. Finally, digitalization and technology upgrading are likely to have an uncertain impact on inequality, boosting access of underserved communities to financial services and supply chains but also potentially displacing low skilled workers at increasing rates.

The Role of Pro-Rebalancing Policies

26. The authorities see rebalancing as a major goal and have aligned their economic targets accordingly. Table C1 matches the 4-dimensional rebalancing framework used in this paper with targets in the last two five-year-plans (2010–2015 and 2015–2020) and recent announcements7. Targets and recent announcements cover all four dimensions of rebalancing, particularly Internal, Environmental and Distributional rebalancing with External rebalancing featuring somewhat less prominently in the authorities’ own objectives.

27. Several rebalancing-enhancing policies are already being implemented… Notable examples include opening sectors to foreign investment, strengthening social safety nets by, for example, increasing budget support for health care, instituting and enforcing heavier penalties on pollution, and supporting the poor through direct transfers. Most policies target individual dimensions of rebalancing, but have positive synergies with other dimensions.

28. And more efforts to advance rebalancing are advisable in two broad areas:

  • Policies that reinforce each dimension of rebalancing

    • External rebalancing: further opening up protected sectors to foreign investment and reducing trade barriers, making the exchange rate more flexible;

    • Internal rebalancing: reduce emphasis of growth targets and their inherent investment bias, further improve social safety nets including pension and healthcare provision to reduce precautionary savings and raise consumption (Zhang and others, 2017), deregulating the service sector, hardening budget constraints of SOEs and LGs while reducing implicit guarantees, continue regulatory tightening to rein-in leverage, reforming the financial sector including dealing with implicit guarantees;

    • Environmental rebalancing: further strengthen environmental standards, increased reliance on market-based “green” incentives, e.g. through implementing environment protection tax;

    • Distributional rebalancing: reforming intergovernmental relations that will increase the resources available to local governments and strengthen equalizing transfers across regions, tax policy that reduces income inequality, including making social security contributions more progressive while broadening income tax payments and instituting wealth taxes like a recurrent property tax, boosting expenditures that target inequality, including direct transfers to the poor and rural investments;

  • Policies that help undo trade-offs across rebalancing dimensions

    • Internal-Environmental trade-off: ensure appropriate on-budget investments in green infrastructure;

    • Internal-Distributional trade-off: Hukou reform, centralizing social welfare and assistance functions allowing for greater support of workers in provinces/sectors most affected by restructuring/deleveraging, bringing on-budget investment needs to support struggling regions;

    • Environmental-Distributional trade-off: centralizing social welfare and assistance functions allowing for greater support of workers in provinces/sectors most affected by environmental controls;

References

  • D. Ding, and R. C. Mano, 2018, “China’s Capacity Reduction Reform and Its Impact on Producer Prices,” Selected Issues Paper, 2018 AIV consultation with the People’s Republic of China.

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  • IMF, 2018, “Regional Economic Outlook: Asia Pacific,” chapter 2, April 2018.

  • Jain-Chandra, S., N. Khor, R. C. Mano, J. Schauer, P. Wingender and J. Zhuang, 2018, “Inequality in China – Trends, Drivers and Policy Remedies,” IMF working paper 18/127.

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  • Lardy, N. R. and N. Borst, 2013, “A Blueprint for Rebalancing the Chinese Economy,” Policy Briefs PB13–2, Peterson Institute for International Economics.

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  • Wingender, P., 2018, “Intergovernmental Fiscal Reform in China,” IMF working paper 18/88.

  • Zhang, L., 2016, “Rebalancing in China—Progress and Prospects,” IMF working paper 16/183.

  • Zhang, L., R. Brooks, D. Ding, H. Ding, H. He, J. Lu, R. C. Mano, 2017, “China’s High Savings: Drivers, Prospects, and Policies,” Selected Issues Paper, 2017 AIV consultation with the People’s Republic of China.

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Appendix A. Indicators in the Rebalancing Scorecard

  • “External rebalancing”: the indicators used are current account balance in percent of GDP and contribution of net exports to real GDP growth.

  • “Internal rebalancing”: indicators reflect three dimensions; demand, supply and credit. On the demand side, the indicators used are the share of investment and consumption in nominal GDP and the differential between the contributions of consumption and investment to real GDP growth. On the supply side, the indicators used are the share of the tertiary sector in nominal GDP and employment and the differential between the contributions of the tertiary and the secondary sectors to real GDP growth. On the credit side, the indicators used are the share of private credit in GDP, credit intensity (the amount of credit needed for an additional unit of output) and the differential in return on assets between SOEs and private enterprises.

  • “Environmental rebalancing”: the indicators used are energy intensity (electricity consumption per unit of output) and average PM2.5 in 74 cities.

  • “Income distribution”: the indicators used are the Gini index, the share of labor income in GDP, the urban-rural income gap, and the growth rate differential between the median and mean of disposable income. The labor income ratio is proxied by the ratio of household disposable income to GDP.

Table A1:

Rebalancing scorecard summary indicators

article image
Note: Green denotes significant progress, yellow moderate progress and red represents reversal of rebalancing. Table A2 explains coloring rules.
Table A2

Rebalancing Scorecard Coloring Thresholds

article image
The algorithm for coloring rules is: if the change in a rebalancing indicator means regress in rebalancing, said indicator is assigned the color red. To distinguish yellow from green, a simple threshold of 0.5 percentage points if the variable is measured in differences or 5 percent if the indicator is measured in annual percent changes is used.

Appendix B. Additional Figures

Table C1:

Matching the Rebalancing Framework Used in This Note to the Authorities’ Own Targets and Recent Announcements

article image
1

International Monetary Fund. We thank James Daniel, Sonali Jain-Chandra, and Markus Rodlauer for helpful discussions. We also thank Weicheng Lian and Yu Shi for their comments. Remaining mistakes are our sole responsibility.

2

The average bilateral RMBUSD rate depreciated 1.7 percent in 2017.

3

For example, the regression coefficient of nominal GDP growth on bank loan growth at the provincial level was 0.63 in 2017 compared to the coefficient for 2011–16 at 0.31.

4

Dibao provides cash assistance to people whose monthly income is below a minimum livelihood threshold. Wubao covers the elderly, disabled and children without supporting family members by providing a basic allowance, medical care, funeral expenses, and 9-year compulsory education if the recipient is under 16.

5

The New Rural Cooperative Medical Scheme and the New Rural Social Pension Scheme, introduced in 2003 and 2009, respectively.

6

As mentioned in the developments section, the PPI reflation of 2017 led to an increase in within-industry credit efficiency. Additionally, less credit-intensive services continued to represent a larger share of the economy. The within-industry improvement will likely fade as PPI inflation normalizes more than offsetting gains in the structure of the economy, thereby returning the economy to a path of rising credit to GDP.

7

Particularly at the 19th Party Congress and the 13th National People’s Congress.

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Cover IMF Working Papers
China’s Rebalancing: Recent Progress, Prospects and Policies
Author: Rui Mano and Jiayi Zhang
Volume/Issue:
Volume 2018: Issue 243
Publisher:
International Monetary Fund
ISBN:
9781484380673
ISSN:
1018-5941
Pages:
17
DOI:
https://doi.org/10.5089/9781484380673.001

Rebalancing slowed in 2017

(Green=substantial progress; yellow=some progress; red=lack of progress)

Growth in domestic demand in AEs

(In percent)

Decomposing the yearly change in trade balance

(In USD billions)

Contribution share to real GDP: demand side

(In percent)

Contribution share to real GDP: supply side

(In percent)

Share in nominal GDP: demand side

(In percent)

Share in nominal GDP: supply side

(In percent)

Winter PM 2.5 in 74 cities

(µg/m³, bubble size proportional to city usual residence population in 2015)

Poverty rural population reducing

(Person, in millions)

China’s Wubao and Dibao program

(In millions of people; in RMB billions)

Gini index

Diverging provinces, 2017

Deflator change: 2017 vs 2011–16

(In percent)

Contribution to real GDP projections

(In percent)

PPI-CPI differential

(In percent)

Total non-financial sector private debt

(In percent of GDP)