If we take a look at the prospects of the Chinese giant at the dawn of this year, we can see how international relations remain on a stable path, despite some tensions emerging from US arms sales to neighboring Taiwan and civil rights issues. In this sense, Washington has become increasingly concerned about the increase in Chinese military arsenals, see the strengthening of the air force and navy in the balance of the Pacific. Relations with Japan have deteriorated since 2012 due to sovereignty over the Diaoyu Islands claimed by both sides: regular raids by Chinese ships into Japanese territorial waters around these territories increased the danger of a confrontation.
The main challenge that lies ahead this year is the rebalancing of the economy. In the last few years, China's economic growth has been based mainly on investment which, as a percentage of GDP, have exceeded 50%, fueling the expansion of real estate assets, local infrastructures and production capacity. Along with the massive credit expansion since 2008/2009, inefficient investments have created bubbles in the housing market and led to high levels of debt for businesses and local governments. Hence the Chinese central administration has repeatedly stressed that it is ready to accept estimates of slower growth capable of rebalance an economy based on exports, therefore dependent on investments, ad a more service-oriented and consumption-based system. On the supply side, this implies innovative growth and increasing productivity, alongside the elimination of wasteful malinvestments, while, on the demand side, the effort will be to increase income and consumption to create a more sustainable balance. China's economic growth continues to slow down, as efforts by the authorities to curb credit and investment growth begin to take effect. In the third quarter of 2014, GDP growth slowed to 7,3% from 7,5% in the previous one, while the average growth rate from January to September was 7.4%. If we look at the past year, GDP is set to grow 7,3%, i.e. the slowest growth rate since 1999. And due to low investment growth, China's economy is expected to grow by 7,0% in 2015. In this scenario, some targeted stimulus measures were introduced to support the economic slowdown, by increasing spending on infrastructure, railways and social housing. have also been introduced monetary measures (40 basis point cut to the base rate for the first time since July 2012, now at 5,60%) to support small and medium-sized enterprises (SMEs) and the agricultural sector, with corporate tax cuts and property sales controls supporting the weak housing sector.
And even if China is by no means immune to weak foreign demand dynamics, the main risks for future growth come from the internal market, in particular the costs arising from the inefficient use of resources resulting from overcapacity in several sectors. The financial vulnerabilities visible in the financial, corporate and real estate sectors and in local governments are interconnected, so that a shock in one sector could lead to a chain reaction. Particularly critical in this sense is the situation of the real estate market.
China's banking sector remains weak and high credit growth in previous years could lead to deterioration of asset quality in the financial sector. Problems in the banking sector could affect the entire economic system or even lead to state intervention. Even if the number of insolvencies is currently low (1%), this percentage will inevitably rise in the medium term. Above all, the questionable quality of assets in the banking sector is of concern. In particular, a major source of the massive lending expansion has come from so-called “shadow banks” whose off-balance sheet activities have exploded due to heavy regulation of the financial system. But without accurate data on shadow assets, the risks to the economy are difficult to assess. However, most of the activity is related to the real estate sector and there are concerns about the exposure of the big banks to the real estate market. Therefore, the Chinese authorities have already introduced measures to curb its banking activity, resulting in lower credit growth. And closely related to potential problems in the banking sector are the finances of local government entities, which played a major role in the massive economic stimulus policy of 2008 and 2009. Local government debt burden has increased due to high investments in infrastructure and real estate, financed through local government loans often through the shadow banking sector.
In this context, according to Atradius the challenge for the Chinese authorities is to implement reforms to reduce the vulnerability of the economy and rebalance economic growth in the medium term without excessively slowing down GDP growth. Public and external debt levels are very low and China has huge international reserves. Domestic savings are at a high level and there are no capital controls in place to limit flight risk. All this in order to create a cushion for the economy in the event of external or internal shocks. At the same time, the government should continue to take targeted stimulus measures to prevent a worsening of the current deceleration. The labor market situation is crucial in this regard, where Generating and sustaining enough jobs is key to preventing potential bad moods and social unrest. Without, however, aggravating the sustainability of the economy and therefore increasing the risk of a further slowdown.
