Will the Chinese Dragon keep flying?

 Below a summary, the complete analysis you find in the pdf.

The main challenges are in the areas of:

Geopolitics/supply chains

With China emerging as a global autocratic power and main strategic rival, its initially gradually improving relationship with the West has turned around and geopolitical tensions are rising. US-China tensions have persisted under the Biden-administration, with Biden putting more effort on rebuilding traditional alliances to broaden pressure on China. Following the trade war and the pandemic, there is a risk that the shift of supply chainsout of China will accelerate. In general (except for some specific goods), we expect such shifts to occur gradually – given the high stakes for globally operating firms – creating time for China to adjust and diversify.

Efficiency/technology/productivity

Beijing’s regulatory crackdown on internet-related firms and the shift to common prosperity has taken investors by surprise. We do not view the regulatory crackdown as a ‘general attack on tech’, as Beijing still sees high-tech manufacturing as a key driver of its technological advance. The question is whether China’s institutional framework will keep generating sufficient productivity growth. Past experiences of Japan and Korea suggest that China’s ‘mixed’ development model – with some modernisation – could work for some years to come. Beijing also has to manage the expected fall of the population and the labour force, and an education/ skills gap, while urbanisation has further to run.

Debt

Recent debt distress at firms like Evergrande are a reflection of China’s high debt and past lending policies, certainly in real estate. China’s high debt levels do put a longer-term constraint on growth, even though a debt-driven hard landing at the macro level is not ourbase case. As China’s debt mainly consists of loans in local currency by Chinese banks to Chinese firms, a debt crisis is unlikely to be triggered by foreign investors. Still, Beijing’s more tolerant attitude vis-à-vis defaults – as the implicit guarantee framework is left behind – shows that creditors should be aware that sometimes defaulting is also a form of deleveraging.

Climate

China is the world’s largest CO2 emitter, but also the largest investor in clean energy. Its huge climate ambitions (peak carbon in 2030, net zero before 2060) will impact individual sectors and regions, particularly regions lagging in the energy transition. Beijing will likely tolerate some slowing of growth if needed to reach its climate goals, but – as indicated by a recent power crunch and subsequent easing measures –  not at all costs. We think that potentially painful trade-offs will become more evident later on in the transition process. At the same time, investments into the energy transition could also generate GDP growth, for instance if China becomes a global leader in producing and exporting electronic vehicles or other products that are needed in the global energy transition.

China’s future growth path will depend to a large extent how effective China will be in managing these challenges. Our analysis results in three potential scenarios for China’s long-term growth trajectory:

A. Muddling through

This long-term qualitative scenario assumes that China will be able to manage its key challenges reasonably well and that the economy will resume its gradual slowdown from 2022 onwards. In this scenario, average growth in 2021-2035 will be a bit below the annual 4.7% needed to reach Beijing’s informal target of doubling GDP by 2035. However, China will reach high-income status in 2023, according to the World Bank’s current classification standards.

B. Confrontation

This scenario assumes the stance of a Western alliance versus China hardens, trade/ tech tensions flare up and strategic competition turns into strategic confrontation. The trade-off between safeguarding growth, on the one hand, and financial stability/environment on the other will become tougher. All of this implies a sharper slowdown of the Chinese economycompared to the Muddling through scenario. Annual growth would average 3.3% in 2021-2035. Beijing would not reach its informal goal to double GDP by 2035. GDP per capita would be around 15% lower in 2035 compared to Muddling through. The direct effect would mean a 0.2 pp reduction in global GDP growth per annum, but there are more important second-round effects.

C. Cooperation

In this scenario, the need to cooperate with China on global – particularly climate – issues triggers a turn for the better in relations with the West. China would benefit from similar tailwinds as Japan and Korea did last century, although the incentive to cooperate now is to fight climate change, not communism. This would help China to continue moving up in thetech value chain, and to strengthen its role in producing goods that are needed globally to support the energy transition. The improved external environment would help to simplify the management of domestic issues. Growth would hold up better than in the Muddling through scenario, averaging 5.2 in 2021-35. Beijing would more than reach its informal goal to double GDP by 2035, while in 2035 GDP per capita would be 15% higher compared to Muddling through.