State of Chinese economy
The Chinese economy’s GDP in 2016 was at $11.2T USD, compared to $18.6T USD in the US and $1.5T USD in Canada (Figure 1). As the world’s second largest economy, reforms to Chinese financial regimes must be closely monitored as they have large implications for every other global nation. China’s earlier growth projection of 6.2% for 2017 has been revised up to 6.7% on strong second half expectations, which is the same level as in 2016. This revision reflects the expectations of continued fiscal support and supply-side reforms (including efforts to reduce excess capacity in the industrial sector). Comparably, Canada’s 2016 GDP growth was at 1.5%, US at 1.6%, and the EU at 1.9%. As shown, the developed markets have held steady in a band between 1.5-2.0%, whereas China is stabilizing around the 6.5% mark. Growth rate is expected to decline modestly in 2018 to 6.4%.
Figure 1: The World Bank. World Bank national accounts data, and OECD National Accounts data files – GDP (current US$Trillion) – from 1986 to 2016
Figure 2: The World Bank. World Bank national accounts data, and OECD National Accounts data files – GDP growth (annual %) – from 1986 to 2016
Future changes to Chinese economy
As foreign manufacturers shift their operations away from China in favour of other countries (such as Vietnam), China only attracts foreign companies targeting the Chinese domestic market. Therefore, China must tackle the transition toward building their domestic economy by addressing two prominent reform issues: escalating debt issuances and developing sustainable domestic growth. China does have the potential to sustain strong growth in the medium term, however, this is highly contingent on their ability to speed up reform changes and become less reliant on debt and investment. With a higher reliance on debt comes a higher risk profile, where currently the total nonfinancial sector debt is expected to reach almost 300% of GDP by 2022 (up from 242% in 2016). This will become a major concern if China’s deleveraging efforts do not intensify.
Figure 3: International Monetary Fund. China’s Economic Outlook: Debt -trending up and China consumes too little
In addition to tackling persistent credit issues, China must find a way to stimulate domestic consumption and develop strong, sustainable growth. At 46% of GDP, China’s national savings are 26% higher than the global average, largely led by the household sectors with abnormally low consumption rates. Without the contribution of consumers within the domestic market, it forces the government to rely on credit financing to sustain economic growth. This generates a vicious cycle where the Chinese economy is pushed further into their credit dilemma.
Effect on Canadian economy
China is Canada’s 2nd largest export partner at 4.3%, following the 75.2% exports to the US in 2016. Of the top three export products to China, the ratio of those to Canada’s total global exports is 17.5% for vegetable products, 18.2% for pulp of wood, and 2.2% for mineral products
In the scenario where there is a downturn in demand from China for commodities, Canadian exporters will react to the weaker appetite with depressed prices in the three aforementioned products and other major natural resources (oil, coal, copper). In the scenario of an upturn, the reverse is experienced and Canada will strongly benefit from increased global commodity demand.
Canadian Exports to China (2016)
Table 1: Statistics Canada. Canadian International Merchandise Trade Database – Merchandise imports and exports between “Canada” and “China”
The Bank of Canada has run simulation models to analyze the effect on the Canadian economy under the scenario where China’s GDP growth could be 1% lower than predictions. The results indicate a 0.1% lowering in the Canadian GDP, which is fairly minimal compared to the 6x impact US has utilizing a similar model. In summary, Canadian financial institutions have the appropriate contingencies set to handle these levels of shocks. Stress tests conducted by the International Monetary Fund in 2013 showed that Canadian banks could withstand a larger shock than even those we saw during the 2008 financial crisis or the recessions of the 1990s and 1980s.