Winter is Coming? Understanding Chinese Waning Growth

Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow

The Chinese economy did relatively well in 2021 thanks to its insulation from the Covid19 pandemic and a very strong external demand. In fact, the year ended with GDP growth above the auspicious number of 8%, thanks to a growth rate of 4% in the fourth quarter.

This rather positive general trend, though, masks a couple of important truths. First, growth came mainly from the outside, thanks both to the robust export results and the higher-than-ever foreign direct investment and portfolio inflows. Domestic engines of growth were, however, really scarce, with consumption growing very slowly and fixed assets investment plummeting in the second half of 2021, dragged by growing problems in the real estate sector. On the positive side, external demand for Chinese exports was stronger than ever, due to pent-up demand after the peak of the pandemic and delayed production in other major economies. At the same time, foreign investors flocked to China following the mantra of “China first in and first out in Covid”. In other words, China’s effective response to contain Covid19 really helped increase investors’ interest in China, but it also incremented the rather juicy interest rate differential between Chinese and US fixed income assets.

Looking ahead, the support of external demand will not be as strong as in 2022. The world, as a whole, will not benefit from such a positive base effect and fiscal and monetary stimuli will start to wane. This is particularly the case for the US. As a result, China will need to rely more on its own consumption and fixed asset investment while considering obvious headwinds. The most important one is the ongoing unwinding of the real estate sector. The tight management of the situation by Chinese policymakers is bound to avert a financial crisis. However, growth is bound to be affected negatively for years, as the real estate sector contributes to one third of fixed asset investment and it is plummeting. Another important side effect of the plummeting investment in real estate is the very slow land sales, a key source of revenue for local governments. These local governments have also been entrusted with the task of refloating the economy by further investment in infrastructure, but their finances have never been worse. As regards consumption, a key factor pushing it down is the very low growth of disposable income. This might be hard to understand when looking at official unemployment figures, which remain very low. However, unrecorded unemployment is clearly higher as part of the migrant workers remain underemployed or even unemployed.

All in all, Chinese economy in the year of the Winter Olympics will clearly need a boost and, even with a boost, it is not bound to grow very fast. Based on last December’s speech by Premier Li Keqiang at the Work Conference as well as provincial growth targets for 2022 recently announced, Chinese policymakers expect China’s GDP to grow between 5 to 5.5%. Although this growth might look appealing, on the back of the ongoing fast deceleration, we should be reminded that it could imply a percentage point lower than that of pre-Covid, as 2019 ended with 6.1% GDP growth. Secondly, it seems clear that a growth rate above 5% in 2022 will only be attained with very strong fiscal and monetary stimuli.

This is, however, easier said than done. Fiscal stimuli in China have long boiled down to infrastructure spending as China cannot rely on automatic stabilizers as both its tax structure as well as its fiscal expenditure are not designed in an appropriate way. In other words, China does not count on fiscal instruments to support consumption during a downturn. While the recent policy mantra, common prosperity, could offer a venue to develop such welfare state, it could certainly not be effective as early as 2022. Furthermore, President Xi’s own interpretation of common prosperity rules out the introduction of a European-like welfare state in China. This means that any fiscal stimulus next year will need to resort to the good old tools, namely infrastructure spending. The expected return of such projects is increasingly low, making it even harder to entice local governments’ interest. Against such background, the monetary stimulus will need to come to the rescue but with a major constraint, namely avoiding excessive leverage. In fact, the People’s Bank of China has been very cautious throughout 2021 even as there were clear signs of a rapid deceleration in the third quarter, as a way to force the deleverage of the economy, especially the corporate sector. In 2022 this will no longer be possible since the monetary policy will need to ease substantially, well beyond the steps taken at the end of 2021. More specifically, both the reserve requirement ratio and the interest rates will need to be slashed to ease funding conditions for Chinese corporates. This will involve households as well as local governments, whose finances have deteriorated very rapidly, not only due to Covid-related reasons but also because of the collapse in land sales given the real estate sector woos.

All in all, the year of the Winter Olympics in Beijing is bound to be a difficult year for the Chinese economy as external demand wanes and domestic demand has a hard time in taking the baton. This is why fiscal and monetary stimuli will definitively be needed to support economic growth. The good news is that China’s response to Covid, in terms of policy stimuli, has been much more moderate than that of the West, making it possible to use that policy space in 2022, a critically important year in political terms, given the expected confirmation of President Xi for at least one more mandate and the huge international attention for the Winter Games. In other words, we should probably not worry too much about China’s growth in 2022 — even if it will remain weaker than pre-Covid levels, but rather about that of 2023. This is even more valid for the years ahead, since the renewed fiscal and monetary stimuli will wane. Such rapid deceleration is truly where the country is heading, and therefore it needs to be considered a structural feature of the Chinese economy.

*This article was originally published by ISPI at



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