Paris, February 11 2022 - Can China counter a steadily declining rate of growth? What does its economic outlook for 2022 really look like? Amidst global geo-economic crises and conflicts, are Beijing’s prioritization of self sufficiency and national security sustainable in the long term? 

In a new policy paper published today by Institut Montaigne, François Godemant, Senior Advisor for Asia to the think tank, examines the remaining assets for economic growth in China. Exports, capital inflows, but also very conservative budget, credit and monetary policies leave margins of support to economic growth that are likely underestimated.

The real cost of Xi Jinping’s carefully crafted strategy lies with decreasing social expenditures, a crisis for local budget financing that was sparked by the central government’s lending restrictions and by limited support for the hard-hit real estate sector. According to François Godement, the rationale for Xi Jinping’s conservative policies is to avoid the risks of external financial dependence, and to be ready to shield the Chinese economy from international geoeconomic or geopolitical shocks.

"As with the so-called 'dual circulation' economy, national security, self-sufficiency in key areas, and capacities are the key components of China's overarching economic strategy. Admittedly, these are short-term priorities: in the longer run, large importer countries carry the most weight in international trade negotiations; the ability and willingness to borrow and increase international debt is the main pathway towards creating an international currency. China's choices reflect a shorter-term perspective on the risks of geopolitical conflict or an international geoeconomic crisis, an eventuality that officials often cite." - François Godement, Senior Advisor for Asia at Institut Montaigne and author of the policy paper.

Economic slowdown: a stable trend? 

There is a consensus that China’s growth is declining. Goldman Sachs has diminished its forecast for 2022 from +4.8% to +4.3%, and the IMF has reduced its growth forecast from 5.5% to 4.8%. This trend goes against statistics that predate the pandemic, with GDP growth in China having averaged 9.44% annually between 1978 and 2018. The warning signs have been stark: a  difficult transition to household consumption and services, a potential bubble economy symbolized by a real estate crash in the summer of 2021, a significantly reduced birth rate, and an energy transition supply crisis in the same year. At first glance, it seems evident that China has major issues with growth and that a long-term slowdown is in motion.

The pandemic did indeed present the Chinese economy with an opportunity, as trade surplus surged and created a rebound effect. Given the particularity of the context and the decline in the rest of the world’s economy, trade economists initially cast this aside as a one-off event. 

Yet, this trade surplus is continuing and even accelerating. FDI and other capital flows into China are not showing signs of slowing down, and short term interest rates remain attractive. 

This begs the question: what explains the contraction of the public budget and what does China’s economic outlook for 2022 really look like? An argument can be made that the factors behind China’s growth slowdown are circumstantial rather than structural issues, and that a stronger force is at hand in the background. 

The structure of China’s public budget

China has been more conservative than all other large economies since the coronavirus epidemic took hold, which engaged in large-scale quantitative easing. Moreover, the general budget had been running behind GDP growth ever since 2014, ​​with expenditures falling faster than receipts 

To understand the dynamics at play behind the government budget, it is first crucial to understand the various streams that comprise it:
1. The “general budget”, which consists of the central and local budgets 

2. The budget of local funds, which are largely government managed and financed by miscellaneous taxes and land sales

3. The budget derived from profit transfers from state-owned enterprises

4. The social security budget, which includes welfare expenditures on health, retirement and unemployment compensation. 

Alongside these four main streams, there are also extra-budgetary expenses from local government financing vehicles, which include shadow banking. 

Several trends have appeared across this structure, which have had a direct effect on budget contraction. These include decreasing sources of revenue for local government and declining land sales, especially in 2021. As a result, local expenditures have felt the contraction the strongest despite growing needs. Areas that are the furthest from the central power and budget, where inequality is the largest and needs for social expenditures the highest, have thus had to bear the brunt of the government’s conservative approach. 

"Even with capital controls in place, China's trade and financial integration with the world is such that low or zero interest rates in the country would result in capital flight. The interest rate differential with the US and EU must be maintained to avoid the situation. Monetary policy is therefore quite restrictive, and China's lending available to the economy, which routinely increased by 15% on year for decades, stands at 6% at the end of 2021." - François Godement Senior Advisor for Asia at Institut Montaigne and author of the policy paper.

Contraction as a coordinated strategy

What is revealed is a voluntary maneuver of the public budget and credit, that consists of holding a tight control over spending and downward countercyclical policies, sparsely loosening the strings of the purse if and when necessary to prevent an economic downturn. China’s general strategy consists of minutely handling its economic vessel. It has opted for a restrictive approach, preemptively cooling different sectors of the economy (such as the real estate sector in 2021), in an effort to withhold economic assets in case of a geopolitical shock. 

After an initial burst of public spending during the first Covid-19 shockwave, the Chinese economy began to rebound. The government reacted by withholding its general budget, bringing the budget expenditure as a share of GDP down by 2.67% compared to 2020. 

Following the same logic of measured oscillation between controlled contractionary and expansionary policies, officials started to invoke early but limited easing measures in the fourth quarter of 2021. These provided for sectoral rather than across-the-board support, and aimed to preempt downturn, inspire public confidence and avert a financial crisis. 

This logic is further being reinforced by monetary policy, which has gone through a similar cycle of tightening and light easing. The growth rate of M2 slowed down from + 11.1% to +8.1% between April 2020 and April 2021. M1 expansion crashed from +14% in February 2021 to +3% in November of the same year. On the other hand, however, a number of other measures, including lower reserve requirement ratios (RRR) for banks, are a step-by-step loosening. They signal a supportive stance while preserving a cautious stance in the name of stability. It quickly becomes obvious that the trends in budget policy are not a fluke. Instead, this is an overall coordinated policy. 

There is an inescapable “externality” to this strategy however: the negative social effects. The cutting down of public spending, especially so at the local authority level, has revealed the depth of inequality of the different regions in China. This has overall led to a social shock, sparing only the wealthiest provinces and cities. In spite of the celebrated policy of poverty alleviation, income distribution has become increasingly unequal, and redistribution through public budgets has diminished. The total unemployment compensation outlay for 2020, is only 0.21% of GDP.  The dibao, or minimum living standard guarantee, has hardly moved up in the same period and is only 0.19% of GDP. 

The reappearance of the Common Prosperity slogan in the summer of 2021 has been seen abroad as an assault on excessive wealth and its displays. However, it may not have been understood that the campaign also serves to counter the impact of negative welfare trends. There is no sense of a strong redistribution policy, and Xi Jinping has decried “welfarism”. 

China’s 2022 outlook: available margins

The current strategy points to a carefully crafted and closely monitored policy by the Chinese government, which ultimately offers China a set of tools that provide a buffer in case of international economic crisis or geopolitical shock. On the one hand they strengthen the iron hand of the central government, and on the other, they feed into Xi’s overall philosophy of minimizing the risks of dependence on the outside world and staying prepared for major world crises. 

The combination of monetary, fiscal, and credit conservatism with a large export surplus, provides China's leadership with a feeling of invulnerability. It therefore focuses on production, while other major economies shoulder the burden of lifting demand. Should an accident happen - and the most likely black swan at this moment is a surge of Omicron, which the authorities are adamant to avoid at any cost - the previous conservative stand described above, and the margins of action that have been preserved, would come in handy.