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Factors impacting the Chinese Slowdown in GDP

Posted October 07, 2014 Rishi Shah

Not so long ago, the Chinese economy was the fastest growing economy in the world, deemed to surpass the USA in absolute GDP terms as the largest economy by size. There are a number of reasons both internal and external, which are responsible for the recent slowdown in growth for China. Estimates for GDP growth forecasts are at 7.6% for this year and set to slow even further to 7.5% in 2015, which may seem to convey strength but they are faltering compared to double digit growth expectations from a few years ago.

 

It is a well known fact that a large proportion of China’s GDP can be attributed to export led growth. The largest population in the world, predominantly located in rural villages transformed into a massive industrial powerhouse by the end of the 20^th century, producing low cost manufactured goods that it exported to the rest of the world, primarily to the West where the culture of consumerism continued to fuel China’s economic development. As a result of the global financial crisis that plunged developed economies in the West into recession, demand for Chinese exports declined rapidly and there was no backup plan. Although growth prior to 2007 had lifted many people from rural towns into an expanding middle class, domestic demand was nowhere near the levels to make China self sufficient and grow internally.

 

An additional hindrance to Chinese growth is the restrictions the Chinese government has placed on opening up its capital markets to indirect investment. A sophisticated and well maintained capital market is essential for the growth and development of an economy. Chinese authorities have placed limitations on the amount and type of investment that can enter the country through its quota system called the RQFI and RQFII programs, disallowing Chinese equity markets from diversifying their investor base. Investors in Chinese equity markets are predominantly retail investors that do not have a long term view of the markets, leading to extreme volatility.

 

Overall, the Chinese economy faces an uncertain future. A government hesitate to implement structural reforms, factors discouraging direct investment such as human rights issues and bureaucracy and a heavy dependence on exports and manufacturing.