Published November 28, 2012
BEIJING – China's economy relies on an excessively high level of investment and risks a potentially destabilizing increase if the government aims to keep growth around current levels for years to come, new International Monetary Fund research suggests.
Already running high as measured by a theory used by economists to assess capital-to-output ratios, investment accelerated between 2007 and 2011 to counter the effects of the global financial crisis, IMF staff wrote in a research paper on China's soaring investment levels.
"Depending on precise assumptions, over this period, China may have been over-investing by between 12 and 20 percent of gross domestic product relative to its steady-state desirable value," the report said.
"Even allowing for elevated investment levels associated with most economic take-offs, the econometric evidence suggests that China is over-investing," it said. "China's predicted investment norm over the last 30 years has ranged between 33-43 percent of GDP. In reality, it has fluctuated in a much broader band of 35-49 percent of GDP."
The IMF says its working papers do not necessarily represent the organization's policy, and that the reports describe research in progress that is published to spur debate.
The potential for severe internal economic imbalances in China stemming from an extended period of investment-driven growth, plus the risk that the excess capacity it creates spills into the global economy, are a recurring theme of IMF research.
A rise in fixed asset investment spending has helped underpin a rebound in China's economic growth in recent months, after seven successive quarters of slowing expansion - the worst run since the depths of the global financial crisis.
China officially targets GDP growth of 7.5 percent this year and analysts broadly believe the government has had an informal annual target of 8 percent or more for years - a level regarded until now as necessary to create enough jobs for the country's 1.3-billion strong population.
In a report earlier this year that Beijing sanctioned, the World Bank - the IMF's sister organization - assumed that China could maintain growth of 6-7 percent a year until 2030 with the right mix of structural economic reforms.
Average annual growth of around 10 percent for most of the last 30 years since China began a landmark program of economic reform, has seen the country transformed from impoverished laggard to the world's second-biggest economy - and likely to take top spot from the U.S. before the end of the next decade.
Beijing said in September that it had given fast-track approval to infrastructure projects worth $157 billion, a move analysts say has been key to cementing a fourth quarter bounce in GDP.
Total planned investment in newly started projects, a leading indicator of fixed asset investment, accelerated to 35.2 percent year-on-year in October from 31.3 percent in September, according to Ting Lu, chief China economist at Bank of America/Merrill Lynch.
MORE INVESTMENT, LESS GROWTH
The IMF stressed there were limitations to the model it was using and the assumptions it made, adding that on some simple metrics, the efficiency of China's return on investment was broadly in line with emerging market economies.
But the report added that by its calculations, a sustained period of over-investment meant that China now required ever higher investment to generate the same amount of growth, forecasting that investment's share of GDP could soar to 60-70 percent from current levels around 50 percent.
"Under such a strategy, vulnerabilities will likely grow in the form of hidden deadweight that will have to be paid in future in one form or another. The cost of financing such an elevated level of investment could undermine overall economic stability," it added.
Whether those vulnerabilities would eventually erupt into a full-blown funding crisis was far from clear, the IMF research said, particularly given China's heavy use of household savings, rather than external financing, for investment spending.
That funding model in itself has added strain which impeded the transition the government has said it wants to achieve in rebalancing growth towards domestic consumption and more dynamic small and medium-sized enterprises (SMEs).
"In China, a large burden of the financing of over-investment is borne by households, estimated at close to 4 percent of GDP per year, while SMEs are paying a higher price of capital because of the funding priority given to larger corporations," the IMF report said.
(Reporting by Nick Edwards; Editing by Richard Borsuk)