|The following is an excerpt which has been republished from World Bank Group’s report From Recovery to Rebalancing: China’s economy in 2021.
Following a collapse in the first quarter of 2020, economic activity in China has normalized faster than expected, aided by an effective pandemic-control strategy, strong policy support, and resilient exports. While swift, the recovery has been uneven, with domestic demand recovering more slowly than production and consumption more slowly than investment. Real GDP growth is projected to slow to 2 percent this year before accelerating to 7.9 percent in 2021, as consumer spending and business investment continue to catch up, along with improving corporate profits, labor market conditions, and incomes. The growth outlook is predicated on the assumption that well-targeted containment efforts supported by the gradual rollout of effective COVID-19 vaccines starting in early 2021 will continue to keep new infection rates low and prevent the resurgence of large-scale outbreaks.
Even as GDP returns to its pre-pandemic level by 2021, the COVID-19 shock has accentuated preexisting imbalances and highlighted structural challenges. The pandemic and ensuing recovery have caused imbalances in the structure of aggregate demand to relapse, as households increased savings, government support stressed investment, and external imbalances widened. Public and private debt stocks—already high before the pandemic—have increased further. The vulnerabilities in fiscal, corporate, and banking sector balance sheets together with rising debt service costs will weigh on China’s growth, following next year’s strong cyclical rebound.
The external environment is expected to remain challenging and highly uncertain. Despite an initial rebound, the global economy remains in recession, and its recovery path is uneven and precarious. In addition, near-term global prospects have recently dimmed amid re-escalating COVID-19 outbreaks and renewed lockdowns in several major economies. Entrenched geo-economic tensions, most notably persistent bilateral frictions with main trading partners over trade and technology, also continue to pose risks to China’s sustained recovery and its medium-term growth prospects.
Navigating near-term uncertainty will require an adaptive policy framework calibrated to the pace of the recovery both in China and the rest of the world. A premature policy exit and excessive tightening could derail the recovery. Against the backdrop of persistent output gaps, still fragile private demand, and emerging deflationary pressures, the return of the People’s Bank of China (PBOC) to a normal policy stance should proceed cautiously. At the same time, monetary policy should return to more conventional tools while phasing out window guidance, lending targets, and relending facilities adopted to provide targeted support in the context of the COVID shock. Similarly, regulatory forbearance measures that were necessary to deal with temporary liquidity problems should be rolled back to facilitate recognition and resolution of non-performing assets and mitigate risks of a “zombification” of bad credit.
Along with a flexible and supportive monetary policy, China could use its fiscal space to hedge against downside risks to growth and ensure a smooth rotation from public to private demand. Focusing these fiscal efforts on social spending and green investment rather than traditional infrastructure investment would not only bolster short-term demand but contribute to the intended medium-term rebalancing to greener and more inclusive growth. For example, some of the special direct fiscal transfers to local governments that were implemented this year could be extended through next year and explicitly targeted to increased social spending and/or green investment by local governments.
Market oriented, structural reforms would help avoid a sharper decline in potential growth, reduce external imbalances, and lay the foundation for a more resilient and inclusive economy. Strengthened insolvency and bank resolution frameworks would facilitate an orderly exit of weak or failing corporates and banks, reduce overcapacity, assist the deleveraging process, and free up resources to flow to more productive uses.
Further extending the liberalization of China’s household registration system (Hukou) to China’s 9 large cities would lower barriers to labor mobility, equalize access to services, and boost urbanization as a driver of growth. Rebalancing fiscal spending from investment to social safety nets would make growth more resilient by encouraging households to reduce precautionary savings, thereby lifting domestic consumption. The demand shift to domestic consumption should be accompanied by further opening China’s domestic market, particularly in services, to enhance competition and facilitate diffusion of knowledge and technologies as key drivers of productivity growth. While benefitting China, further action to reduce trade barriers, including in services, would increase opportunities for further growth in global and regional trade. This would provide an important fillip to the global recovery.