People's Republic of China: Selected Issues

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781475524383.002.A005

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People's Republic of China: Selected Issues

Author: International Monetary Fund. Asia and Pacific Dept

Publication Date:: 12 Aug 2016

eISBN:: 9781475524383

Language:: English

Keywords:: ISCR; CR; China; IMF staff estimate; GDP; market; growth transition; product mix; growth slowdown; investment slowdown; slowing GDP growth; Consumption; Exports; Spillovers; Emerging and frontier financial markets; Global

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The People's Republic of China: Selected Issues

Abstract

The People's Republic of China: Selected Issues

Rebalancing in China: Global Spillovers¹

China's transition to sustainable consumption-based growth is desirable, benefiting the global economy and reducing longer-term tail risks, even if it entails a near-term slowdown.
However, given its size, openness, high investment rate, and high import content of its investment and exports, a slowdown in China is likely to have strong global spillovers.
Negative trade spillovers will weigh on global growth, but the effects will vary with each country's level and type of exposure to China.
China's rebalancing away from investment has already contributed to a slowing in demand for, and prices of, many commodities.
Financial spillovers from China are on the rise through strong trade linkages and rapidly rising financial linkages.

1. The Chinese economy—now the world's second largest at market exchange rates—is undergoing substantial structural change to a model driven increasingly by consumption and services (rather than public investment and exports), with growth gradually slowing to a more sustainable pace. This transition is good for China and good for the world, benefiting global growth and reducing tail risks in the longer term.

2. China's transition to a new growth model and a more market-based economy is inherently challenging and has been bumpy at times as exemplified by recent market turbulence. Given China's size, openness, and high investment rate and the high import content of its investment and exports, a slowdown in China is likely to entail strong global spillovers through trade, commodity prices, and confidence, with attendant effects on global financial markets and currency valuations. Spillovers from China have increased over time as China's economy has grown in size and integrated more closely with the region and the world, both in trade and finance.

3. Trade spillovers from China's growth slowdown weigh on global growth, especially in Asian countries, reflecting their higher exposure to China. The exposure to final demand in China has been increasing for nearly all Asian economies. Value added in exports related to final demand in China was relatively high (more than 4 percent of GDP) for Australia, Korea, Malaysia, Singapore, Taiwan Province of China, Thailand, and Vietnam. Staff analysis (IMF, 2016d) suggests that a 1 percentage point investment-driven drop in China's output growth would reduce G20 growth by ¼ percentage point. Duval and others (2014) estimate a growth spillover effect of about 0.3 percentage points for the median Asian economy, with each country's sensitivity increasing with its exposure to China in terms of value-added trade. Cashin, Mohaddes, and Raissi (2016) obtain similar spillover estimates for ASEAN-5 countries and also find that the effects here increased substantially over time (for example, twofold between 1992 and 2012 for the median country), reflecting the rising weight of China in the trade of each country. Rafiq (forthcoming) also finds similar growth spillover effects on four ASEAN emerging markets.

4. Spillover effects in the short term vary with each country's level and type of exposure to China. “Unitary” rebalancing—defined as a 1 percentage point reduction in investment growth combined with a 1 percentage point increase in consumption growth—will have little effect on China's GDP growth itself because the shares of consumption and investment are about the same. However, this broadly growth-neutral rebalancing in China will weigh more on countries with higher exposure to China's domestic investment, while exposure to China's consumption will provide a buffer and may boost exports of some countries. Staff analysis (IMF, 2016a) indicates that the most adversely affected economies in Asia are those closely integrated with China through the global value chain and heavily exposed to its investment activity (Korea and Taiwan Province of China). In contrast, economies with a larger share of consumption exports, such as New Zealand, experience smaller negative spillovers as they benefit from the increase in China's consumption demand.

5. The evolution of China's product mix provides challenges and opportunities for other countries. Staff analysis (IMF, 2016a) shows that China's changing trade patterns have important effects on advanced upstream economies. China is increasingly competing with upstream suppliers, affecting economies such as Japan, Korea, and Taiwan Province of China, as well as Germany and the United States. These effects have become more pronounced since the Global Financial Crisis, and increasingly in higher-technology products. Staff analysis (IMF, 2016b) also shows that China is exiting some labor intensive sectors. This trend is creating opportunities for frontier and developing economies, particularly in Asia (e.g., Cambodia, Lao P.D.R., Myanmar, Vietnam) to enter those sectors and to satisfy China's rising consumption demand.

6. China's growth transition has important implications for commodity markets and exporters. China is a major importer across a range of commodities, especially metals, for which it accounted for about 40 percent of total global demand. China's investment slowdown has therefore had a significant impact on the demand for, and prices of, those commodities closely related to investment activities—indeed, metal prices have fallen steadily since early 2011 by almost 60 percent on average. This has generated substantial excess capacity in mining sectors and forced exporters to adjust to lower revenues. To the extent that China's slowdown and rebalancing contribute to lower commodity prices, net commodity exporters can also be affected.

7. China's rebalancing has contributed to a slowdown in demand for, and decline in prices of, many commodities. For investment-related commodities, the global consumption slowdown has been larger than can be attributed to China's slowing GDP growth alone, suggesting the important effect of the rebalancing of the economy. By contrast, the consumption of food commodities has surprised on the upside, reflecting the relatively higher demand for protein and vegetable oil as per capita income rises. China's demand for crude oil remained strong in 2015, partly reflecting the accumulation of inventories. Staff analysis (IMF, 2016a) suggests that much of the impact on commodity exporters has come through lower commodity prices, rather than export volumes. This analysis also suggests that China's rebalancing accounts for between one-fifth and one-half of the declines in broad commodity price indices, with marked differences across commodities (although the wide range highlights that the contributions are quite sensitive to the specifics of the analysis).

8. Global and regional financial sensitivities to China have increased, in particular since the global financial crisis (IMF, 2016a; IMF, 2016c). Even before the recent bout of volatility, the co-movement of Asian and Chinese markets had been rising. The region's asset return correlations with China have increased further in both equity and foreign exchange markets after the crisis. In fact, countries with a higher degree of business cycle synchronization with China have, on average, seen their equity markets move more closely with China. Several economies in the region, such as Korea, Singapore, and Taiwan Province of China, have substantial financial links with China, both directly and through Hong Kong SAR. Moreover, several other countries, such as Japan, Indonesia, and Malaysia, are affected by episodes of global risk aversion. To the extent that uncertainty about China's growth and policy outlook contribute to such "risk-off" episodes, these countries may also be affected. Financial spillovers are likely to rise further with rapidly growing financial linkages with China, including through the ongoing internationalization of the renminbi and China's gradual capital account liberalization.

References

Duval, R., K. Cheng, K. H. Oh, R. Saraf, and D. Seneviratne, 2014, “Trade Integration and Business Cycle Synchronization: A Reappraisal with Focus on Asia,” IMF Working Paper 14/52 (Washington: International Monetary Fund).
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Cashin, P., K. Mohaddes, and M. Raissi, 2016, “China's Slowdown and Global Financial Market Volatility: Is World Growth Losing Out?” IMF Working Paper 16/63 (Washington: International Monetary Fund).
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Rafiq, S., forthcoming, “When China Sneezes Does ASEAN Catch a Cold?” (Washington: International Monetary Fund).
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International Monetary Fund, 2016a, Asia and Pacific Regional Economic Outlook (Washington, April).
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International Monetary Fund, 2016b, China and the CLMV: Integration, Evolution, and Implications, forthcoming.
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International Monetary Fund, 2016c, Global Financial Stability Report (Washington, April).
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International Monetary Fund, 2016d, World Economic Outlook (Washington, April).
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Prepared by Joong Shik Kang.

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