With the conclusion of China’s annual National People’s Congress this week, the country’s 13th Five-Year Plan is now official. Chinese leaders have committed to maintaining a growth floor of 6.5% during 2016-2020 while gradually liberalizing the market.
Of course, balancing such goals is easier said than done. We expect the Chinese economy to grow by 6.5% in 2016, but we do not believe that the Chinese economy is in a position to sustain that rate of growth over the next several years. The fundamental transition that China seeks to accomplish has taken other countries decades and has often involved significant turbulence.
Setting relatively high growth rates for 2016-2020 is thus a red flag: China’s leaders are either overly confident in their ability to manage the economic slowdown in the next five years, or they simply intend to focus on hitting short-term economic numbers at the expense of critical market-oriented reforms, which would exacerbate key threats to the economy (e.g., the property market weakness, industrial overcapacity, bad debt escalation) and eventually lead to a hard landing.
With this in mind, MNCs should take into consideration three possible scenarios for China’s economic trajectory during 2016-2020. This approach will help executives adjust internal expectations and prepare for market shocks. See below for FSG’s scenarios overview for the Chinese economy in 2016-2020:
Base-case scenario: Economy faces a bumpy ride (likelihood: 55%)
In this scenario, the government is able to slowly shift to a consumption-based economic model with gradual market-oriented reforms, but market volatility will be unavoidable. This “muddle through” scenario promises an average growth rate of 6.0% over the next five years. We continue to believe that this is the most likely scenario; however, after witnessing heightened market instability in the past few months, we have lowered the likelihood of this baseline forecast from our 2015 projection.
As China’s economy slows during its structural shift, multinationals should re-evaluate competitive strategies and cost structures to adapt to a more volatile market environment and more sophisticated customers. Economic protectionism against foreign companies will also mount as the economy slows.
Downside scenario: Reforms are delayed, which leads to a market crash (likelihood: 35%)
In this scenario, the government continues to delay key reforms, which results in a hard economic landing triggered by a property bubble burst and high levels of non-performing loans. Even though the Chinese government still retains enough policy ammunition to stimulate growth over the next 2-3 years, it’s simply not sustainable for the country to rely on monetary easing and fiscal stimulus packages to revive the economy without addressing fundamental imbalances. FSG has upgraded the downside likelihood from 25% in 2015 to 35% today, due to the government’s hesitant reform efforts and the continued rise of debt levels.
If the government chooses to further delay critical reforms (e.g., restructuring state-owned enterprises, lifting pricing controls, and reducing financial repression on consumers), the expected average annual growth rate for 2016-2020 could be as low as 4.0%. While this is not the most likely economic trajectory for China, MNCs need to evaluate the potential impact of a drastic slowdown in the Chinese economy and build contingency plans accordingly.
Upside scenario: Comprehensive reform is accelerated (10%)
In this scenario, re-balancing economic reforms are brought up to speed under effective government management, and consumption grows rapidly to support the economy. This would allow the Chinese economy to expand at an average growth rate of 6.4% for the period of 2016-2020. MNCs would enjoy a much more attractive business environment in China if crucial market-oriented reforms were successfully implemented according to the present timelines in China’s 13th Five-Year Plan.
However, the possibility of this “ideal world” scenario remains very low, because GDP expansion in this case should primarily come from significantly higher consumer spending. Given the limited social welfare coverage and high degree of financial repression currently imposed on Chinese households, most consumers in China are still struggling to purchase homes and save for retirement.
China’s economic re-balancing will create a much more volatile business environment for multinationals in the next five years. Therefore, executives must learn how to more effectively evaluate and capture opportunities amid increasing economic uncertainties.
For an in-depth analysis of this topic, FSG clients can access the full report on the client portal. Not a client? Contact us to learn more.