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Economy

China's growth to slow to 4.1% by 2025: Tokyo think tank

TOKYO -- China's growth rate could fall to 4.1% by 2025, according to new projections by the Japan Center for Economic Research. The downtrend will put a drag on four major Southeast Asian economies.

     This is the first time the Tokyo-based think tank has released a report detailing the medium-term prospects of not only Japan but also China, Thailand, Indonesia, Malaysia and the Philippines.

     JCER reckons the Chinese economy will decelerate significantly over the next 10 years because of structural problems, such as ballooning local government debts, and the waning impact of monetary easing. In its report, the center outlines three potential trajectories: a baseline scenario, along with optimistic and pessimistic forecasts that depend on how Beijing's reforms play out.

     It is under the baseline scenario that Chinese gross domestic product growth would slow to 4.1% a year by 2025. If reforms successfully improve the business environment, the world's No. 2 economy would likely maintain a 5.5% annual growth rate. If the reforms fizzle, the think tank projects a decline in growth to about 3% a year.

     The four key Association of Southeast Asian Nations members are likely to see their GDP growth taper off at a moderate pace after 2016, partly due to China's slowdown.

     JCER plans to release this report, titled "Medium-term Forecast of Asian Economies," once a year.

     The following is a compilation of the report's major points.

The challenges ahead

China faces a host of problems. The working-age population has begun to shrink, as the birthrate declines and the median age rises. Local governments' debt load is also growing heavier as property values fall. These issues could weigh on growth and, partly due to the insufficient social insurance system, exacerbate inequality. The Chinese Communist Party leadership could face intensifying social instability.

     If these challenges are left unresolved, it will be difficult for China to escape the middle-income trap.

     Thailand, meanwhile, must contend with the effects of political instability and military control of the government, as well as a declining working-age population.

     Malaysia's gross national income is in the ballpark with high-income nations. Yet the government in Kuala Lumpur needs to address various issues, such as the brain drain driven by its Bumiputra affirmative action policy for ethnic Malays and reform of state-owned enterprises.

     Thailand and Malaysia should enhance their education standards to produce high-skilled workforces. They also need to boost productivity and encourage innovation, following the examples of Singapore and Taiwan.

     In terms of per capita GNI, Indonesia and the Philippines rank below China, Malaysia and Thailand. Indonesia and the Philippines thus need to improve their business environments, including by strengthening legal and regulatory frameworks. Attracting more foreign investment in infrastructure is crucial. They also need to develop industrial clusters and promote urbanization -- prerequisites for adding value to products and services.

     If these four countries take full advantage of the planned ASEAN Economic Community to boost trade, and foster a cycle of rising domestic demand and wage growth, they will have a shot at realizing these reforms.

China (baseline scenario)

Under JCER's baseline scenario for China, real GDP would grow at an average rate of 5.9% from 2016 to 2020, then by 4.5% from 2021 to 2025. The annual rate would drop to 4.1% by 2025.

     While President Xi Jinping has called for adjusting to a "new normal," progress on structural reforms may be slow.

     Personal spending is expected to gradually overtake capital spending in terms of contributions to GDP growth. Yet consumption growth is also likely to slow at a moderate pace. China's potential growth rate -- how much the economy can produce over the medium to long term without sparking higher inflation -- is on the decline.

     In 2015 and 2016, relatively high asset prices and monetary easing should help to maintain growth momentum. This will be temporary: As the impact of these factors wanes in 2017 and beyond, the potential growth rate will drop to 5%-5.5% on average from 2016 to 2020, with real GDP growth also losing steam.

     Improvements in China's business environment will be harder to come by. Total factor productivity is forecast to drop from around 6% between 2006 and 2010 to around 4% between 2011 and 2015, and later to around 2% between 2021 and 2025.

     Over the years, China's capital stock has increased sharply due to the indiscriminate pursuit of development projects. Some of these projects will be scrapped due to lower land prices, and the number of abandoned facilities will increase. Consequently, China's fixed assets will likely continue deteriorating. Capital's contribution to the potential growth rate is seen falling to a little over 3% in the 2016 to 2020 period, from around 4% in 2011 to 2015. From 2021 to 2025, the figure is projected to sink below 2%.

     Aside from sluggish property prices and a drop in income from land sales, China faces other structural problems. Efforts to address them will determine whether the economy follows the baseline scenario, or veers onto more optimistic or pessimistic paths.

     In rural areas, cash income per capita grew around 8%, on average, from 2001 to 2005. In urban districts, wages (at state-owned companies) increased 14% during the same period.

     The working-age population has begun to decrease, after peaking at 1.06 billion in 2013, according to the U.N. Surplus labor in rural areas has hit bottom due to industrialization -- a situation known as the Lewis Turning Point. But if local governments fail to settle their mounting debts, it could hinder rural wage growth along with development and urbanization. Widening wealth gaps among different regions could spur social instability.

     Meanwhile, the state-run China Development Bank is advancing urbanization projects. Beijing is also building a number of institutions -- the Silk Road Fund, the Asian Infrastructure Investment Bank and a Chinese insurance investment fund, along with the BRICS group's New Development Bank -- to promote infrastructure investment at home and abroad.

     The question is whether lenders will pay heed to profitability and efficiency. Failure to do so could hamper China's economy.

     China is moving toward liberalizing interest rates. In June 2015, it decided to scrap restrictions on bank lending, which were capped at 75% of deposits. Moreover, the government is working to internationalize the yuan and wants it included in the basket of currencies that underpins the International Monetary Fund's Special Drawing Rights.  

     If these financial reforms amount to monetary easing by another name, they might generate an economic bubble. Over the medium to long term, Beijing needs to free up capital flows and carefully reform its financial system.

     The keys to medium-term growth will be strengthening institutions, facilitating business activity and tackling environmental problems. 

China (optimistic scenario)

Thanks to success with structural reforms and an improved business environment, China under this scenario would maintain growth of around 5.5%, even from 2021 to 2025. The country would benefit from higher total factor productivity and a resultant rise in investment.

     Total capital formation would also contribute to the growth rate -- around 2.5% -- in the same period due to increased domestic and foreign investment. Higher labor productivity would help lift wages and boost consumption as well. However, this would increase imports, meaning China's trade surplus would rise only modestly.

China (pessimistic scenario)

In this case, China's growth rate would fall significantly due to the economy's structural limits. Growth would decelerate sharply starting in 2017, with the rate dropping more than 1 percentage point on average each year.

     In April 2015, Chinese Finance Minister Lou Jiwei said the country would have a more than 50% chance of falling into the so-called middle-income trap -- unless it overhauls its agriculture, family registry, labor, land and social security systems over the next five to seven years.

     Lawrence Summers, professor at Harvard University, and Barry Eichengreen, professor at the University of California, Berkeley, note there are historical precedents for high-growth countries experiencing plunging growth rates.

     If this happens to China, growth could fall to around 3% in the period from 2021 to 2025. Local governments would likely slip into default; rural areas would lag far behind urban centers in terms of growth in per capita cash income.

Read more online

To access JCER's economic outlooks for Japan, China, Thailand, Indonesia, Malaysia and the Philippines, please visit http://www.jcer.or.jp/eng/economic/asia_forecast.html

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