Roland Berger study: China’s magic GDP growth threshold of 7% is in danger

• Chinese structural problems threaten the magic GDP growth threshold of 7%
• Effects on our growth are significant
• Stagnation, “credit-based stability”, “new normal” or “new growth” – companies should prepare for change

MUNICH, 14-10-2015 — /EuropaWire/ — The statistics currently being generated by the Chinese economy make sobering reading: Exports, which experienced rapid growth of 18.9% per annum between 2000 and 2013, plunged to just 6.1% growth in 2014 and in the first half of 2015 managed a mere 0.9%. Key domestic indicators such as rail transportation volume (a drop of 10.1%) or new construction projects (a fall of 15.8%) are on the slide. The magic GDP growth threshold of 7% is in danger. This is the conclusion reached by the latest Roland Berger study, “China’s direction: Stagnation, ‘New Normal’ or a ‘New Growth’ Model”. As author Professor Burkhard Schwenker, the company’s former CEO and current chairman of the Roland Berger Advisory Council, states, “China currently exhibits all those elements with which we associate uncertainty. Developments in China are happening on many levels and for that reason, are difficult to interpret as the prognoses can be contradictory. Our study presents possible scenarios facing China in the future, thus providing orientation.”

The challenges facing China

Schwenker and his co-authors have analyzed a number of structural challenges that China is facing: First of these is the steep increase in the level of public, corporate and private debt. As of 2014 this stood at USD 25 trillion – a 25-fold increase over 2000 and corresponding to 282% of China’s GDP – twice the figure it was eight years ago. Second, the study highlights the overcapacity existing as a result of overinvestment. Ten years ago Chinese companies were running their factories at 90% capacity. This figure has dropped to 60%. Third, in terms of its demography, China has also reached a turning point. The one-child policy, the so-called “demographic dividend” that has thus far played a major role in China’s dynamic growth, is now beginning to backfire with the number of people of working age in rapid decline since 2012. Estimations are that by 2050 the potential labor force in China will have decreased by 220 million people.

Threat to magic growth threshold of 7%

Since 1978, GDP in China has grown by a remarkable average rate of 9.85% per annum. This has been a significant driver of growth for many other regions including Europe. Growth has, however, been falling since 2010 with the IMF currently forecasting a drop below the 7% threshold. This 7% figure constitutes a tipping point, which Chinese premier Li Keqiang has identified as the level of growth required to create 10 million jobs in China year on year and thus maintain unemployment in large cities at a constant rate of 4%. As co-author of the study, Roland Berger expert Tobias Raffel, confirms, “The bottom line is that China is of pivotal importance to the world’s economies. If Chinese growth stalls, the positive growth impetus witnessed in the past could just as quickly turn negative.” Two decades of expanding nearly three times as fast as the world economy have seen China account for as much as 40% of global economic growth. For Europe alone over the last five years, exports to China have grown to EUR 164 billion making China Europe’s second most important trading partner. According to the Roland Berger study, if growth in China dropped to 5%, growth in Germany would drop by 0.8 percentage points and, given Germany’s position in Europe, the knock-on effect on other European economies would be of a similar order of magnitude.

Development through 2020 – four scenarios

Looking to the future, the Roland Berger experts have mapped out four scenarios taking on board the details of China’s new five-year plan. Automation, digitization, new production processes, e-mobility, resource efficiency and modern services will replace resource-intensive industrialization. Coupled to this will be new education campaigns to improve labor productivity to double per capita income to USD 12,000 by 2020. Also, the Chinese government plans, among other measures, to increase privatization primarily in banking, energy and rail transportation, and to promote more entrepreneurship at small and micro levels.

In the first scenario, reforms are not fully implemented and international growth with its associated knock-on effect on the Chinese economy does not materialize. This “stagnation” scenario would lead to a struggle on three fronts: An economy in the doldrums, increasing over-indebtedness and no resolution of the structural challenges facing China. The second scenario is “credit-based stability”, which, while promising continued growth above 7%, would not address the fundamental structural problems. In the medium term the results would be no different from the first stagnation scenario. More promising is the so-called “new normal”. Based on references made by Chinese President Xi Jinping to a “new normality” in the light of lower growth rates, this scenario is dependent on reforms being carried out punctually regardless of growth prospects. The final and most promising scenario is the tellingly entitled “new growth” by which China could return to growth rates upward of 7%. This scenario assumes rapid global economic growth in combination with the far-reaching political reforms that have been laid out in the five-year plan.

Prevention is better than cure

It is difficult to predict which of the four scenarios is most likely as all four could play out, so the Roland Berger experts recommend that European policymakers and businesses adopt a course of preventive action with the following options. The first is to support China’s efforts to guarantee market access, for in the words of chief analyst Klaus Fuest, “Putting foreign market players at a disadvantage will not make it any easier for China to get its economy on track.” Second, it is in Europe’s interest to negotiate a free trade agreement with China. Some progress in the Comprehensive Agreement on Investment (CAI) has been made since November 2013, but conditions for joint ventures and a list of those investments from which foreign firms are excluded remain unresolved. Third, as Burkhard Schwenker explains, “Every percentage point of growth that we can achieve elsewhere reduces our dependence on an uncertain China.” The topics are well known. A swift conclusion to the TTIP negotiations would generate synergies and prosperity gains of around EUR 120 billion, which in itself could cushion many of the negative effects of slower Chinese growth. There is a need to make more of the benefits of the single European market and to invest more in European infrastructure.

Companies, too, are best advised to keep their options open by looking at all four scenarios and planning accordingly. Analysis of footprint and impact, playing out the above scenarios and developing smart strategies is, according to analyst Fuest, “the only way to achieve greater certainty as to which scenario will ultimately play out.”

For Burkhard Schwenker, maintaining the status quo is not an option: “Even if we remain optimistic, assuming the new plan works and our ‘new growth’ scenario becomes reality, the environment for European companies will change dramatically. They will be faced with new Chinese competitors, the number of Chinese global leaders being likely to jump sharply in the years ahead.”

SOURCE: Roland Berger