What does it mean for the future of the Chinese economy?
The recent growth figures splits experts into two camps. First, there are those who doubt the reliability of the raw data used to obtain the figures questioning how such results were achieved amid stock market chaos, smaller fixed-growth investments, and slower trade growth. Then, there are others who see them as evidence that the Chinese economy has proved once again that it is robust and nimble enough to respond quickly and adroitly in the face of mounting headwinds.
Despite a stock market collapse that wiped out about 30% of value (over $3 trillion of wealth) within a couple of weeks, China's second quarter GDP figures released on July 15 beat all expectations and surprised a chorus of economists who thought a 7% growth would be hard, if not impossible, to achieve. The key figures fall roughly in line with government's expectations for 2015 with an array of indicators pointing north. So, what is driving the growth of the Chinese economy?
Up until very recently, the Chinese economy has been driven by investment and manufacturing destined primarily for export. In the future, export is unlikely to retain its pre-eminence as the chief engine of growth. The Chinese economy is moving from an export-led, low-cost producer economy toward one driven by domestic consumption.
Still, while many expect the export engine to slow down, there is no evidence to suggest that it will run out of steam anytime soon. China's exports rose 2.8% in June from a year earlier, and export contribution to economic growth increased from 0.1 percentage points in 2014, to 1.3 in the first quarter of this year. Export will continue to fuel the Chinese economy for some time to come.
Investment has been the second engine of the Chinese economy. It has transformed China's landscape with an impressive network high speed rail, highways and remarkable buildings. But in so doing, it has burdened local governments with huge debts and led to an overcapacity in much of the economy. For instance, a big chunk of apartments are vacant and major steel and cement factories are running at a low capacity. There is little room for these industries to expand to sustain growth in the future. Investment contributed a mere 1.2 percentage points to growth in the first quarter of this year.
But old habits die hard. The recent downward pressure has compelled the government to resort once again to conventional state-led infrastructure projects and steadying the housing market to cushion the slowdown and avert a hard landing. This has raised concerns that long-term goals have been sacrificed for short term interest. The Chinese economy is not a free market, not yet, and one expects the government to pull the state-led investment lever, albeit as a last resort, whenever needed to prop up growth.
Much of the growth in the future is expected to come from domestic consumption. It is the new chief engine of the "new" Chinese economy. But consumption spending has remained stubbornly difficult to improve significantly. And things are unlikely to change in the short term. While the buoyant stock market trading in late June and early July contributed to economic growth in the second quarter, it is likely to have a detrimental impact on consumer spending in the second half of the year. Consumers lost a significant chunk of their investment and therefore have less disposable income to spend.
The government has deployed as arsenal of policies over the last few months to prop up consumption and stop the economy from tumbling. Last June the People's Bank of China cut the benchmark lending rates for the fourth time since last November by 25 basis points to 4.85%, and lowered the level of reserves banks are required to hold by 50 basis points to spur lending to stimulate growth.
There is one thing for sure: The Chinese economy is going through a major transformation. The real answer to how the new economy might look like in 10 or 20 years is that none of us really know.