Why the IMF Is Wrong About China’s Economic Slowdown

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The sudden slump in Chinese exports last month prompted IMF deputy chief David Lipton to warn next month’s projections for global growth will very likely drop below the current prediction of 3.5%. Chinese exports declined by an astonishing 25.4% compared to the same period a year earlier. The unexpectedly sharp fall combined with a dramatic sell-off on the Shanghai and Shenzhen stock exchanges a month earlier sparked new concerns that China’s role as “factory to the world” is beginning to go off the rails.

An important concern raised by the flood of bad news was whether China’s economic woes might be enough to trigger a new recession in the United States, which still ranks as China’s most important trading partner. Those fears are overblown. The most immediate effects of the slowdown will be felt in Asia. The impact on the U.S. and Europe is expected to be minimal.

One reason for not being overly concerned is that in contrast to Europe and the U.S., China still has plenty of economic firepower. It has more than enough resources to deal with any immediate problems resulting from the difficult transition to a more sustainable growth rate. While central banks in Europe and the Federal Reserve in the U.S. long ago reduced interest rates to near zero and engaged in multiple bouts of quantitative easing, China still has numerous options that it can ball back on. Even Moody, which recently downgraded China’s outlook from “stable” to “negative”, continues to give China an Aaa3 credit rating.

See also: China’s Exports Crash 25%—But Hold On

In contrast to Western countries running huge deficits, China’s budget deficit is only around 3%. It has enormous cash reserves, and if it wants to increase exports and boost employment, it can easily devalue the renminbi by as much as 10%. In contrast to the West, which emphasizes profit and is desperately trying to cope with the downside of globalization, China’s top priority is to head off civil unrest, and safeguard its fragile social fabric. It is willing to operate at a loss in order to maintain stability, and at least for the moment, it has more than enough resources to do that. While the IMF’s reassessment may be unwarranted in bringing extrapolated fears on whether or not China may cause a global crisis, it does signal that very real changes are taking place. And these changes have a clear impact on the business environment.

China currently accounts for roughly 10% of the world’s exports and 8% of its global imports. Even if China were to drop out completely, 90% of the world’s commerce would still be there to pick up the slack. In contrast to exports, the dollar amount of China’s imports in February dropped by only 13.8%, and part of that decline was due to a global fall in commodity prices, especially oil. The expectation is that a decrease in Chinese imports will probably have the greatest impact in Asia, and among exporters of commodities, particularly Australia and the Middle East. Luxury goods may also experience a drop off. The impact on companies in the U.S. and Western Europe is expected to be minimal. Although it is difficult to come up with a precise figure the actual impact is likely to be less than a half percent.

All this means that China still has considerable breathing space to institute badly needed reforms. Chief among these is a transition from an over reliance on infrastructure projects which create jobs, but produce little in the way of quantifiable financial returns. Unrealistic investments in real estate have managed to keep some of the population working, but it has also resulted in hundreds of uninhabited “ghost cities” that may eventually be headed for the demolition heap. In the next year or so, China will need to wean off the regional governments, municipal administrations and non-productive state-owned companies that are currently supported for political reasons, but which produce little or no return on investment. Shadow banking, financial institutions and instruments that have gone unregulated, also needs to be brought under control, and the financial system will have to become much less opaque if investor confidence is to be restored.

China’s growing consumer economy has created an attractive market, which will ensure that China’s economic growth is at least between 4%and 5% a year. That is lower than Beijing’s current target of 6.5% to 7% but it is still more than double the projected growth in more mature economies such as the U.S. or Europe. The IMF reassessment and any analysis on downturn in China simply are indicators that the environment has changed. The major difference is that from now on, business in China will require a more nuanced strategy and better analysis than the heady days of double digit growth, when almost any enterprise could easily turn a profit. Though a global slowdown in unlikely, the rules have changed.

Nuno Fernandes is director of the strategic finance program at IMD business school in Switzerland.

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