China’s Beijing Daxing International is one of two international airports serving Beijing. It began operations in 2019 and has been nicknamed "the starfish.” (UBS)

A few days back, I had the pleasure of sitting down at UBS Studios with our Chief China Economist Tao Wang, who recently published a book titled “Making Sense of China's Economy.” You can watch our 10-minute conversation at this link. Below is an excerpt with some takeaways.

Alejo: I found your book to be refreshing and fairly balanced. I wanted to start with the basics: How fast do you think China can grow over the next five years?

Tao: China, for the first 30 years after 1980, was growing on average at 10%per year. In the past decade, it slowed down to about 7%. Of course, there has also been excess investment in areas such as property, and China is also facing tech restrictions and decoupling pressures.

Nevertheless, putting all this together, I think China can still grow maybe 4–4.5% in the next five years on average. It's certainly much slower than before, but if you think about it, China is already a USD 17 trillion economy—comparable in size to the EU—which is still going to create a lot of addition to global growth.

Alejo: Demographics, excesses in the property sector, and a very high debt-to-GDP ratio are the most frequently debated challenges China’s economy faces. How severe do you think these are, and can China overcome them?

Tao: These are some very big challenges. On demographics, China has already started to revise its population policy and try to encourage people to have more children. However, based on other countries' experience, it's unlikely to reverse that trend. The good news is that China still has surplus labor in the rural areas. In addition, the retirement age is very young, currently about 54. So if you extend the retirement age by three years this decade, you can add 40 million people to the labor force. So the demographic trend has a lot of challenges, but actually China is not running out of people to work at the moment, so it's not quite binding.

On the property sector, starting with the supply side, a lot of construction has been carried out. We estimate about 127 million units of urban housing have been built since 2008, and housing ownership is over 80%. On the demand side, we talked about demographics and the shrinking of the population, and urbanization is slowing. So China is going through a very deep property adjustment. We think that with some policy support, it can stabilize—but it's not going back to the dynamism of years past.

On the debt side, the corporate sector has done some deleveraging in recent years, but the government, especially local governments, have accumulated significant debt and do not have a lot of cash flow to repay. The good thing is that China has a very high savings rate, and most of the debt is domestic and lies with the banks that are state-owned, and there is very little risk of bank runs because there are also capital controls. So overall I think that debt is very high, but it's unlikely to trigger a debt crisis as many other emerging markets have historically seen. The bad thing, of course, is that the system is carrying a lot of debt weight, which is in turn crowding out resources from going into more productive sectors. All this will be a dampener on growth.

Alejo: I wanted to ask you about how the geopolitical map globally is being redrawn. This is triggering a reshuffling of supply chains. There's a lot of reported intent to move capacity out of China closer to the US, to Europe, and to emerging markets as well. How much is this having an impact on China’s economy?

Tao: The supply chain shift has definitely accelerated since the US-China trade dispute a few years ago. Now, with increased geopolitical tensions and US export bans on technology, there is likely to be a push for further moves, especially in the tech sector. If one looks at the macro level data in terms of China's share in total global exports, or the overall foreign direct investment trends, you don't yet see a huge shift. But at the micro level, we know that's happening. At the same time, there's also some shift in supply chains toward China if the production is made for the Chinese market. Net-net, over the next few years, we will probably see a reduction in net foreign direct investment going into China. I think China's exports will also face some headwinds. So those numbers will probably show up in the macro picture in the next few years.

Main contributor - Alejo Czerwonko, Chief Investment Officer Emerging Markets Americas

Content is a product of the Chief Investment Office (CIO).

Original report - Making sense of China’s economy, 5 July 2023.