China Economic Outlook 2015

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1 Key Developments in Brief Economic development Growth drivers Risks GDP growth between 7-7.2% Managed slowdown occurring Fundamentals remain healthy Economic risk increasing Stabilizing policy adjustments Deepening of structural reforms Services and retail Urbanization and infrastructure Industrial upgrading Falling energy prices Slowdown in new job creation Deflation risk Industrial overcapacities Real estate market slump Price levels Foreign trade Labor market Falling prices area of concern CPI increase around 2% PPI fall to continue Foreign trade to remain sluggish Shift to higher value-added exports Expanded use of RMB Service sector jobs expanding Wages to increase around 1 Productivity growth struggling Macroeconomic Indicators growth in % GDP Investment and output Utilized FDI Fixed asset investment Industrial production Price levels Consumer prices (CPI) Producer prices (PPI) Foreign trade Exports Imports

2 Economic Development 2015 Economic growth in China will continue to fall in 2015, with GDP growth estimated to be between %. Rather than experiencing an abrupt crash, the economy is slowly downshifting from high to medium growth. Given the size of the Chinese economy in absolute terms, this slowdown is natural, and unlike after previous slowdowns, a significant rebound in growth should not be expected. Economic transformation and the implementation of reforms are an ongoing process attempting to amend China s economic development model towards a more sustainable growth pattern. Deepening reforms have the potential to cause shortterm economic disruptions as mounting structural problems are eradicated. Tolerating a slowdown in certain sectors of the economy in favor of shifting the growth momentum towards domestic consumption, services and innovation will test policy makers commitment to accepting lower levels of GDP growth. The structural slowdown to medium growth is at present occurring within a generally stable macroeconomic environment. Key macroeconomic indicators have been slowing, but are generally still expanding at high levels. Key targets of economic policy in 2015 will focus on preventing a substantial slowdown of GDP growth as well as on defying the risk of deflation. Targeted easing of monetary policy to facilitate money supply as well as measures to encourage and support SMEs and export companies, coupled with easing of real estate restrictions and public spending on infrastructure, aim to counter the risk of growth slipping below 7%. Monitoring new job creation in 2015 will be of substantial importance, as more heavy-handed stimulus measures are expected should the stillresilient labor market weaken. Given its economic weight, even at moderate growth rates of around 7% China can maintain its position as an important global growth engine will mark a decisive year for deepening reforms to bring China on a more sustainable development path. Downward pressure and economic risk, however, are increasing, forcing the government to strike a careful balance of supporting economic growth while advancing its ambitious reform agenda. Reforms Restructuring and economic upgrading are vital in shifting to a new growth model. China is in the midst of massive structural reforms. Manufacturing s share of China s economy is declining, while the service sector now contributes the largest share to GDP. After years of rapid economic growth, China needs to adjust its growth model, which is heavily reliant on investment and exports. Achieving this requires boosting domestic demand and services, while the industrial sector needs to move up the value chain. Progress already occurred in 2014: the government announced that 80 key tasks were completed and another 108 reform points have been initiated. By the end of 2015 the tertiary sector is expected to contribute to about 5 of GDP. Among other areas, steps to improve resource allocation by strengthening market mechanisms, opening monopolies as well as reducing market restrictions in services can be expected this year. In an effort to free up savings for domestic consumption, expanding the social safety net will increasingly draw policy attention will mark a crucial year for deepening and accelerating the comprehensive reforms. Despite the advances it should be noted that profound structural changes take time and are only gradually taking shape. Reforms will encounter 2

3 economic and political headwinds and the actual reform scope as well as speed in various areas will differ widely. Key areas of reforms Strengthening of market mechanisms Administrative reforms Opening of service sector Progressing rule of law Tax and fiscal reforms Price Levels Financial market liberalization Bureaucracy reduction Reform of SOEs and monopolies Expansion of social and health insurance Reform of household registration system Consumer prices increased by only 2. in 2014, with price increases in the last quarter being particularly weak. Absent of a strong stimulus and a recovery of oil prices, upward pressure on consumer prices will continue to be weak. Reflecting industrial overcapacity and falling commodity prices, producer prices have been falling for 34 consecutive months. Overall price levels in 2015 are expected to remain at low levels, with consumer inflation increasing at around 2%, while producer prices are unlikely to recover during the economic slowdown. Given the low level of price increases, the risk of deflation will be a policy concern, but with GDP expanding at around 7% and with sufficient policy tools at hand it is unlikely to evolve into a macroeconomic threat. Foreign Trade 2014 marked the third year foreign trade failed to reach its growth target, underlining persistent weak global demand and falling demand in the wake of lower economic growth in China. Export performance will remain vital for GDP growth, but growth is likely to see greater fluctuations. Together with increasing competition from Southeast Asian countries, especially in low-end manufacturing, exporting companies are coming under pressure. Processing and lowtech manufacturing is expected to further shift to inland regions or relocate to lower cost Asian countries. In the future exports of more sophisticated goods as well as services are likely to gain in importance. Developed markets will remain the most important, but export growth to emerging economies, notably within the ASEAN region, will accelerate. Imports have been sluggish in 2014 as commodity prices dropped and Chinese demand cooled. The situation is likely to persist in 2015, with imports only growing at low levels. Record current account surpluses are increasing the pressure for the RMB to appreciate against the USD. Given the weak global environment there is, however, a chance that the Chinese government will depreciate the RMB in order to boost exporting manufacturers should GDP growth prove too low. Policies to facilitate trade in a weak global environment can be expected to include measures to increase usage of the RMB as well as new free trade agreements and expansion of the new Silk Road. Labor Market Employment growth remained resilient in the face of slower economic growth thus far, adding 13 million new jobs in 2014 with urban unemployment stable at about 4%. The service sector represents the largest share of GDP and has evolved to a major contributor for growth which has had a positive effect on job creation. In general, expansion of the service sector generates more new jobs per percentage point of GDP growth. However, some sectors of the labor force, notably record numbers of university graduates, are 3

4 struggling to find employment. In 2015 job creation will be particularly important, as the government will carefully monitor the labor market performance as economic growth slows. Wage increases in 2015 will stabilize at about 1. As was the case in 2013 and 2014, productivity growth will be outpaced by wage increases, undermining China s competitiveness while posing a key challenge for companies. More detailed information on labor market conditions can be found at the GCC s Labor Market and Salary Report 2014/15. Risks and Growth Drivers A slowdown in the real estate sector, dealing with industrial overcapacities, and falling price levels pose risks to economic growth in Increasing debts of local governments as well as corporate debt are a risk to the financial sector. Another risk is that the current anti-corruption drive coupled with stricter fiscal controls for local government spending, for all its potential long-term merits, may contribute to more cautious decision making, contributing to slower growth. Lower economic growth starting to affect new job creation may develop into a considerable risk. A challenging global economic environment with lackluster growth further poses a risk to China this year. Should GDP growth lose momentum in the beginning of the year, higher levels of intervention at the cost of progress on reform becomes likely. For new growth drivers to establish themselves will continue to be an ongoing process. In 2015, China s economy will to a large extent continue to rely on investments and exports. Structural changes are, however, beginning to affect the growth drivers. Growth in services will again outpace that of manufacturing. Retail growth is likely to stabilize at the current high levels. Falling energy costs may boost consumers spending power. Generally, the importance of e- business and mobile internet will be on the rise. Urbanization projects and infrastructure investments will continue to drive fixed-asset investments, which will be a pillar of growth in Industrial upgrading and the need to increase productivity in manufacturing, and increasingly in the highly backward agricultural sector, are also expected to contribute to growth. As for regions, growth in the western and central provinces as well as in lower tier cities will outpace growth in the major economic centers. For further questions please contact: Max J. Zenglein, Economic Analyst Phone:

5 Key Economic Indicators Growth in percent on year-on-year basis, except PMI GDP 12% 11% 1 9% 8% 7% 6% 5% 4% 3% 2% 1% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Price levels 4% 3% 2% 1% -1% -2% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -3% -4% Consumer price index Purchasing price index 5

6 Jan/Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan/Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec China Economic Outlook 2015 Key Economic Indicators Growth in percent on year-on-year basis, except PMI Foreign trade Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -2-3 Exports Imports Industrial production 11% 1 9% 8% 7% 6% 5% 4% 3% 2% 1% 6

7 Jan-Feb Jan-Mar Jan-Apr Jan-May Jan-Jun Jan-Jul Jan-Aug Jan-Sep Jan-Oct Jan-Nov Jan-Dec Jan-Feb Jan-Mar Jan-Apr Jan-May Jan-Jun Jan-Jul Jan-Aug Jan-Sep Jan-Oct Jan-Nov Jan-Dec Jan/Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan/Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec China Economic Outlook 2015 Key Economic Indicators Growth in percent on year-on-year basis, except PMI Retail 16% 14% 12% 1 8% 6% 4% 2% Fixed asset investment 25% 2 15% 1 5% 7

8 Key Economic Indicators Growth in percent on year-on-year basis, except PMI Foreign direct investment 3 25% 2 15% 1 5% -5% -1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -15% -2 Business sentiment: purchasing manager index Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Manufacturing Non-manufacturing Note: An index above 50 indicates business expansion, while an index below 50 indicates contraction. 8

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