MNI INTERVIEW: China’s Post-Covid Rebound Won’t Last - Pettis

China’s growth will slow to 2-3% despite hopes for a robust rebound once Covid restrictions are relaxed, as the nation’s new leadership confront a legacy of too much debt and a bumpy transition to consumption-led growth, Beijing University professor Michael Pettis told MNI.

The twilight of China’s debt-fuelled development mode will force China’s new leaders to confront structural changes that have been a long time coming and raise the fiscal burden on local governments to finance Beijing’s push to boost consumption, he said in an interview.

“Big tectonic movements are not impacted much by political events in a country” Pettis said, referring to October’s Party Congress that delivered President Xi Jinping a third term. “The high growth era is over, more benign growth for the economy is inevitable as is the needed rebalancing required for the next growth model to begin”.

Persistent structural imbalances makes Pettis wary about the sustainability of any rebound in growth once China relaxes its Covid policies.

“Once things in China get back to normal, GDP growth will spike similar to the 8.1% in 2021, and everyone will say 'that's great, China’s back', but the bounce won’t last long,” said Pettis, who has written extensively on the need for the country to reshape its growth model.

China’s debt-to-GDP ratio has been increasing for several years, which Pettis said is evidence that spending on new infrastructure projects is becoming less productive in driving growth. Growth slowed to 3.9% y/y in the third quarter, a shadow of the double-digit rates powered by infrastructure-led stimulus after the Global Financial Crisis. (See MNI POLICY: China's New Leaders Face Challenges In Reform Push)

“The fast growth era of high savings and investment has come to an end” he said, adding that “this trend was happening before Covid and will continue after.”

Pettis looks to Japan as an analogue of China’s economic future as it faces a reckoning of its multi-decade accumulation of debt. He believes growth will slow to 2%-3% and stay at that level for several years as it transitions towards increased domestic consumption and pays off liabilities accumulated during the era of rapid expansion. (See MNI: China Will Struggle To Hit 2022 Target On Stimulus Delay)

“Japan has been undergoing a similar adjustment for a long time and has experienced stagnant growth levels. China looks set to be going down a comparable path - Covid has not changed this trend,” said Pettis.

ASSET SALES

One of Xi’s signature policies is Common Prosperity, a plan to raise more people into the middle class that will need local governments to change their financing models. Local governments have been forced into asset sales by tighter financing rules and a cooling of once-hot property markets.

“The authorities' previous revenue streams of land sales and easy access to credit are not what they once were. This shows Beijing is saying the old model is coming to an end,” Pettis said.

Pettis views the sale of local government assets to fund increase spending commitments as a wealth transfer in favour of households, as funds are being used to pay down debt, aid the property sector and boost welfare. “Expect more reallocation from local governments as China looks to boost domestic demand going forward” he said. (see MNI INTERVIEW: China Must Lift Growth To Curb Capital Outflow)

It’s logical that local governments will be asked to shoulder the burden as taxing corporations harms the economy and the rich are not sizeable enough in number. “Expect to see local authorities drag their heels on this quite a lot”. “There is talk of things like increasing pension payments and affordable housing to assist the economic transition” he said.

Pettis said vested interests have historically made transitioning extremely hard. “The US made the change in the 1930s but only after a sharp drop in GDP and high unemployment, and Japan has been trying since the 1990s and experienced prolonged stagnation - neither option is attractive”.