The short answer, at least according Chinese President Xi, who set it as a long-term goal in his speech last November, is yes.
If you look at history, President Xi could have a point. China has managed to double its economic size five times since 1980, or once every seven to ten years. So it should be able to do so one more time in the next 15 years as that would only require an average annual growth rate of 4.7%, much lower than the 9.3% over the last four decades.
However, it’s much more complicated than that. As economies mature, economic growth trends tend to slow. Data shows that Chinese growth has already slowed sharply in the last decade. If this trend continues, or accelerates as some China observers have argued, then it would be difficult if not impossible for China to double by 2035. With that, let’s take a look at key arguments for and against China maintaining strong enough growth to achieve its economic goal.
Reasons why China’s growth will continue to slow and potential offsets
An aging population that hurts potential growth: China used to be known as the low-cost manufacturing center of the world due to its large labor force. However, the working-age population peaked in the mid-2010s and is projected to shrink by 69 million, or 7%, over 2021-35. While an aging population is an issue in most developed economies, China’s issue is exacerbated by its one-child policy. However, it appears that the worst part of China’s demographic deficit is behind it. Additionally, new technologies provide an offset to China’s demographic shift. Japan has also shown that it’s possible to expand the labor force during times of population contraction by bringing in more female, older and foreign workers.
A much higher debt-to-GDP ratio makes it harder to maintain economic stability: China’s debt-to-GDP ratio was stable around 150% until 2009 and then surged to 283% in 2020. Some have argued that China will need another buildup of debt to double its GDP again, but does this extrapolation make sense? Like most countries, China experienced an explosion of debt following the Global Financial Crisis due to massive stimulus and negative shocks to growth. However, hard lessons have been learned and top Chinese officials have made stabilizing debt levels as a top priority on their agenda.
Growth depends on China’s ability to change from an investment-driven model to a consumption driven model: China’s investment-driven and export-reliant growth model, while contributing significantly to its economic growth, has been criticized as unbalanced and unsustainable. As such, China needs to transition to a consumption-led growth model. While there is truth to this argument, investments should continue to provide growth tailwinds. China still has a huge internal market and continued urbanization can drive investment and production. The story also goes beyond domestic funding of investments. Despite strong expectations for supply-chain relocation, China has seen a swift rebound in foreign direct investment (FDI) to become the largest FDI recipient in 2020.
While it is possible for China to meet its goal of doubling GDP by 2035, it is no easy task to maintain an average growth rate of 4.7% for the next 15 years. Even if China were to pursue needed reforms, headwinds include high debt levels, green growth efforts such as lowering carbon emissions, and a tough geopolitical environment. Therefore, it will be important for top policymakers to carefully manage macroeconomic risks to prevent them from derailing the country’s growth path.
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The Biden administration recently announced that vaccines originally expected to be delivered by the end of June will now come a month earlier and that the U.S. is on track to have 600 million vaccine doses by the end of July. Paul Single, a managing director at City National Rochdale, the investment management arm of City National Bank, joins us this week to discuss the vaccine rollout’s effect on growth, inflation and the Fed’s policy path.
One- to two-week view: The euro should remain range bound in the coming weeks. Former ECB President Mario Draghi has been appointed Italy’s new PM and should be able to pass his reform agenda as he has overwhelming support in both houses. Overall, European growth (recently revised down by the EU) continues to lag U.S. growth on the back of differences in COVID-19 restrictions, the magnitude of fiscal support provided, and proposed and vaccine distribution in the U.S. outpacing that in Europe. As such, a material rise in EUR/USD back to its December highs will be challenging. On the monetary front, ECB officials have pushed back on euro strength, noting that there are many tools to combat euro appreciation.
Three- to six-month view: With the factors that pushed the euro higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Moreover, the prospect of more fiscal stimulus and a faster vaccine rollout in the U.S. relative to Europe increases the chances for a return of U.S. exceptionalism and U.S. growth that outpaces European growth. Near-term optimism on a recovery in global growth helps push the euro higher, but the single currency should dip into year-end as U.S. yields rise, the European Central Bank continues to fight deflation, and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained euro rally without European economic exceptionalism and the prospects of ECB rate hikes.
One- to two-week view: The pound remains in a tug of war between the U.K.’s status as a G10 vaccination leader and economic headwinds from lockdown measures. On balance, the view remains constructive, as the first effect should have the greater impact because the U.K. is also set to reopen its economy ahead of other EU countries. Keep an eye on Feb. 22, as that is when Boris Johnson is expected to outline the easing of lockdown measures. With the EU-U.K. relationship poor, the next round of talks on services is unlikely to go well for the U.K., but for now near-term price action will likely be driven by the race between the vaccine and infections.
Three- to six-month view: The U.K.’s vaccine rollout outperformance and resulting economic optimism has provided a boost to the pound. Compounding this support has been the message from the BoE that it is unlikely to impose negative rates. While the vaccination program is encouraging, there are reasons to remain cautious. The first reason is that the economy isn’t moving ahead of its peers but simply catching up to them. The second factor is the impact of vaccinations. While the relative pace of vaccinations will affect the relative trajectory of the U.K. economy over the next few quarters, it won’t impact the long run sustainable economic trend rate, which is more relevant for the medium term GBP. In this respect, Brexit, which has been overshadowed by the pandemic, has been and should continue to be an economic drag. This means that the U.K. economy will not only have to recover from its pandemic underperformance but also from the damage done by the narrow trade deal that is fundamentally bad.
One- to two-week view: USD/JPY should remain driven by broader USD dynamics. In Japan, the state of emergency has been extended to March 7 and should increase headwinds to growth and inflation. To the extent that an extended state of emergency leads to a sharper deceleration in economic activity and BoJ dovishness, the yen will face depreciation pressure. To this end, infection numbers are trending down, so state of emergency measures appear to be working, but the speed of vaccine rollouts remains important. Outbound investment flows have had a limited impact of FX, but rising U.S. yields and a reduction in JPY longs remain supportive of USD/JPY. On monetary policy, the Bank of Japan’s upcoming policy assessment is due to be announced in March.
Three- to six-month view: The medium-term outlook is still biased toward a stronger yen. However, rising U.S. yields have pushed USD/JPY higher and represent the strongest headwind to further yen appreciation. Given this, it should be noted that U.S.-Japan real yield spreads still support a move toward 100 yen per USD even if U.S. rates move somewhat higher. Regarding monetary policy, markets will be looking out for the results of the BoJ’s policy review due in March. If media reports are correct, the BoJ could signal the de facto end of yield curve control if the bank announces a wider trading band. An emerging point of discussion is the impact of Japan’s vaccine imports. Estimates put Japan’s vaccine bill at around $2-$3 billion, or roughly half of Japan’s total trade surplus with the U.S. in February of last year. This could provide some support to USD/JPY, although this support is likely temporary.
One- to two-week view: Canada’s latest jobs data disappointed market expectations but the majority of losses could be traced to temporary restrictions in Ontario and Quebec. As vaccines continue to roll out and cases decline, the subsequent reduction in restrictions should see a recovery in the labor market. On the monetary policy front, the Bank of Canada is reviewing its policy framework in 2021 and is considering an inflation overshoot approach like the Fed, although market reaction has been muted as the BoC remains in early stages of discussion. Fiscal spending and stronger growth in the U.S. also provide support to the Canadian economy through increased export growth and investment activity. The CAD remains susceptible to global risk sentiment in the near term but the medium-term outlook remains constructive as increased immunization supports increased mobility, external demand and oil prices.
Three- to six-month view: The medium term CAD outlook remains constructive. While the USD has picked up some support, further CAD appreciation is supported by the Canadian economy’s proximity to the U.S. due to increased U.S. demand for Canadian exports. Moreover, the CAD should benefit from a move up in commodity prices as the global economy continues to recover. Notably, oil has been a strong performer on a year-to-date basis and the outlook remains bullish. On monetary policy, the BoC has adopted a more positive tone and laid down the parameters for eventual QE tapering, adding to the positive medium-term outlook. In essence, the bank has tied paring back policy support to the economy performing “in line or stronger” than the bank’s forecast, making the country’s vaccine progress something to keep an eye on. Finally, there is the potential for federal elections this year but the impact on CAD is likely modest and mainly tied to possible changes in fiscal policy.
One- to two-week view: While recent indicators show China’s economy continuing to grow, there has been a moderation in the pace of this growth and inflation. Nevertheless, relative economic outperformance, a current account surplus, and relatively high yields form the base for a bullish view and support a continued drift lower for USD/CNY. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but a persistent yield advantage and strong foreign investor inflows support further gains. On the geopolitical front, Biden and Xi held their first phone call since Biden became president. As expected, Biden pressured China on its human rights record. While the U.S. will take a more conventional approach to China, expectations remain for Biden to retain a tough-on-China approach.
Three- to six-month view: The yuan’s year-to-date appreciation against the dollar index reflects supportive fundamentals and solid fund inflows. China’s export sector has outperformed, and while there is medium-term risk that a resumption in production in the rest of the world could undermine this, the risk for an immediate setback is limited. On the flow front, bond inflows remain solid and should continue given China’s relative yield advantage. Regarding the central bank, the PBoC has yet to signal any strong resistance to CNY gains except for a continued relaxation of measures designed to control outflows. This implies that Chinese officials are not yet uncomfortable with recent currency appreciation.
One- to two-week view: Expectations remain for the AUD to weaken. The central bank remains dovish, extending its QE program and reiterating its commitment to keeping rates low and hitting its inflation target. As such, the RBA’s balance sheet expansion should see Aussie bounds outperform U.S. treasuries. While some key economic indicators point to a stronger domestic outlook, uncertainty remains high. Case in point, Australia announced a snap five-day lockdown for the state of Victoria. Meanwhile, tensions between China and Australia continue to linger but have only led to a limited economic impact thus far, but any moderation in Chinese economic activity or fiscal tightening will impact Australian commodity export volume.
Three- to six-month view: Recent price action has been driven by strength in key commodity prices, with iron ore being a particularly important catalyst, as prices continue to benefit from a rebounding Chinese economy and disruptions to supply chains outside of Australia. However, Chinese economic growth has started to moderate and other producers are ramping up production. This is particularly important as commodity prices are a key driver for the Aussie. Regarding monetary policy, the RBA announced an extension to its QE program. While history shows that QE has had a limited impact on exchange rates, it should still lead to a weaker AUD on the margin. As for trade, Australia-China trade tensions continue to linger, but, critically, China is not expected to put restrictions on iron ore due to the lack of alternative supplies.
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