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Slowing GDP growth in China is leading to weaker demand for commodities, contributing to lower global commodity prices. According to the Chinese National Bureau of Statistics (NBS), real GDP growth slowed to 7.4% in 2014, below the government target of 7.5% and the slowest annual growth rate in 24 years. To boost growth the government is trying to push the economy towards a more consumption-led growth model, but this could take some time (see our China QNB Economic Insight 2014). The IMF expects the slowdown to continue, which could push commodity prices down further in 2015 and beyond. This will add to the deflationary pressures that are threatening the global economic recovery (see our commentary on 25 January 2015).

 

China GDP and Commodities

 

The slowdown in growth in China is a consequence of past overinvestment that has led to a build-up of excess capacity in the economy. Overinvestment has contributed to a decline in housing prices and a build-up of financial vulnerabilities in the shadow banking system, which are also dragging down growth. The government has provided a significant package of stimulus measures to support economic growth including tax breaks, financing for social housing, and accelerated investment spending, particularly high-speed railways. At the same time, the Chinese central bank has made large liquidity injections into the banking system and loosened monetary policy to avoid a credit crunch from the crackdown on shadow banking.

Over the medium term, the government is counting on structural reforms to boost growth through a shift to a more market-based, consumption-led growth model as opposed to a public investment-led one. To achieve this, the government plans to liberalise interest rates and the financial sector more generally, introduce market–based pricing of resources and utilities, allow greater private ownership in state-owned enterprises and ease restrictions on urban migration. Additionally, plans to introduce pensions and medical insurance should encourage consumers to spend some of their savings, while lower taxes and minimum wages are aimed at increasing consumer income. Over time, these measures could change the economic model of Chinese growth, with private consumption as the dominant contributor, but this will take time.

In the short term, China is struggling to manage the transition to consumer-led growth. As a share of GDP, private consumption has been broadly stable at around 36% since 2007. In advanced economies the share of consumption in GDP is typically considerably higher, for example it is around 70% in the US. Private consumption growth in China has been falling in line with the broader economic slowdown. Retail spending growth declined steadily from 19% in 2010 to 12% in 2014 (on a nominal basis). This shows the transition will make a growth slowdown inevitable.

Looking forward, private consumption is likely to slow further. Consumer confidence could be shaken by slower GDP growth and potentially higher unemployment (currently 4.1%). Risks in real estate could also be a drag. Households have a significant portion of their wealth tied up in real estate and, with property prices falling across China, this could lead to greater restraint on private consumption.

With private consumption and investment both slowing, the growth slowdown is expected to continue, despite government stimulus measures. The latest IMF forecasts released last week are for growth to slow to 6.8% in 2015 and 6.3% in 2016. Based on the historical relationship between real GDP growth in China and global commodities, slower growth and weaker demand from China is likely to lead to lower global commodity prices by around 11% in 2015 and 5% in 2016, broadly in line with the latest IMF commodity price forecasts. This could add to the global disinflationary pressures that are contributing to what we have called the Great Deflation in 2015.


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