Managing the Transition to Private-Consumption-Driven Growth in China

Growth in China has been on a decelerating path. Activity has been supported by a huge expansion in credit-fueled investment—in 2012 investment reached close to 50 percent of GDP and credit reached almost 200 percent. Although this expansion spurred financial deepening and provided a timely global growth impulse after the Great Recession, policymakers are now reluctant to continue stimulating the economy given the risks of inefficiency, deteriorating asset quality, and financial instability. Off-budget spending by local governments has also raised contingent fiscal liabilities, with the augmented fiscal deficit now estimated to be 10 percent of GDP. Moreover, imbalances between private consumption and investment have intensified, even as the economy’s external imbalances have narrowed. A decisive move to contain these imbalances may be accompanied by lower medium term growth than achieved by China in recent decades, but this is a trade-off worth making.

More subdued growth in China would affect the rest of the world through lower import demand and lower commodity prices, but the net effect should be positive if the right policies are in place. First, because China accounts for only 8 percent of global consumption, the negative spillovers would not be unmanageable. Second, better policies and more balanced growth sharply reduce the risk of a hard landing.