China?s lower GDP growth in the first half of the current year has led many to surmise a hard landing, given the lower demand for its exports. How true are these fears?
A commonly held view about China is its growth has been fuelled by exports. Exports have surely been important. But not as important as domestic investment. The share of net exports of goods and services (exports minus imports) to GDP was at a maximum of 23.1% in 2005. Thus, even during the robust years of economic boom after China?s entry in the WTO in 2001, net exports hardly fetched a quarter of the Chinese GDP. On the other hand, domestic investment, measured by gross capital formation, hardly fell below 40% of the GDP any time during the last decade.
An equally prevalent misconception is foreign investment powering economic growth in China. In 1981, foreign investment was 3.8% of total investments. The share increased to 11.8% in 1996 and thereafter steadily declined. During the last decade, it has averaged around 4% of total investments. With such low share, foreign investment can hardly ?power? aggregate demand and GDP growth.
?Non-foreign? domestic investment has been most significant in China?s capital formation. During the 1980s, funds from the central budget contributed a lot to investment. Over time, ?self-raised funds and others? became the largest source of domestic capital formation. During the last decade, self-raised funds accounted for more than 70% of domestic investment with the share of resources from central budget reducing to less than 5%.
Self-raised funds and others are extra-budgetary resources mobilised by central and provincial governments for investment in fixed assets. They include capital raised by issuing bonds, funds obtained from individuals and donations. These are not reflected in the central or provincial budgets.
The bulk of domestic investment in China is targeted towards fixed assets in construction and installation. Around 60% resources are devoted to construction and installation, while 25% is on purchase of equipment. Construction includes almost all scale-based projects such as real estate, paving of rail tracks and roadways, water conservation projects, sewerage, communication projects and all other projects associated with land and real estate development. Equipment purchased is for use in various construction projects.
Fixed assets are created the most in manufacturing, followed by real estate, transport, water conservancy projects and mining. Sectoral composition of investment in fixed assets shows manufacturing and real estate accounting for 31.8% and 23.3% of investments in 2010. The corresponding shares in 2003 were 26.4% and 23.6%, respectively. Share of transport in investment has reduced marginally from 11.3% to 10.8% during this period. The share of water conservancy projects has increased to 9% from 7.8%, reflecting the policy thrust. Share of mining has increased from 3.2% to 4%, underpinning the increase in mining projects.
The main impetus of China?s economic growth is clearly the large domestic investment funded by extra-budgetary resources and deployed in manufacturing and real estate projects. The accelerated investment has maintained China?s GDP growth by producing multiplier benefits. New projects have created jobs and generated incomes for increasing consumption. High investment and high consumption have acted as twin propellants for GDP growth?far more powerfully than exports.
The story, however remarkable, provokes some questions. How are the enormous extra-budgetary resources mobilised? And, is the process sustainable in the foreseeable future?
Resources have been largely mobilised from the commercial banks. Large bank lending for commercial projects have maintained the construction boom. The ownerships of projects are mixed. While state-owned enterprises own many projects and benefit from generous bank credit, collectives and private enterprises also do so on many occasions.
But is this sustainable? Banks have been lending hard due to controlled interest rates and also because non-performing assets are periodically ?washed away? by injections of fresh capital by an amply cash-rich Chinese state. There is no reason why they should not be able to continue doing so. But the lending portfolios might change. If manufacturing projects yield less due to low demand?both domestic and overseas?more credit might move to real estate, mining and other high-return projects. State-owned banks in socialist China are also driven by returns simply because they want to keep credit rolling. More credit to profitable sectors, if necessary by printing money, will ensure smooth running of the virtuous cycle of easy credit, high investment and steady growth, notwithstanding falling exports.
The author is visiting senior research fellow in the Institute of South Asian Studies in the National University of Singapore. He can be reached at isasap@nus.edu.sg. These are his personal views
