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Is China Really Overinvested? Provincial Data Suggest a Nuanced View

A widely held view of the Chinese economy is that it is overinvested. The logic is as follows. China's manufacturing and export-led growth model requires that a large percentage of GDP be invested rather than consumed. The official desire to make this model self-funded and not rely on foreign savings (capital inflows) means that domestic savings must be sufficiently high or, equivalently, consumption must be sufficiently contained. This, in turn requires a heavy role for the state, rather than the market, in ensuring sufficiently high savings.

This state-led, investment-led, export-led model was successful for several decades. GDP growth was high and inefficiencies relatively low. But as the economy has become more sophisticated in recent years, (and global growth has slowed), the market has not been allowed to play a more decisive role as envisaged under the 13th Five-Year Plan, the government's current economic blueprint. The result has been a period of growth that was too fast, and investment too high. Debt has risen sharply, credit quality has declined, and the sustainability of the trajectory of China's growth path has come under question.

The conclusion that Chinese investment (and GDP growth) must consequently slow has been taken as near gospel. But is that view unconditionally correct? S&P Global's China Senior Analyst Group broadly agrees with this view, but argues for a more nuanced assessment. Drawing on provincial as well as sectoral data, we conclude that while some parts of the Chinese economy are indeed overinvested, many areas remain underdeveloped. In particular, the central and western provinces face investment gaps in infrastructure, energy and, in some cases, property.

Under this line of thinking, investment needs to be rationalized and redeployed - not necessarily reduced, at least not drastically. This objective, in turn, requires changes in policies that allow the redeployed investment to be financed. Most importantly, the economy first needs to be put on a more balanced and sustainable growth path. This requires action to reduce credit growth and the creation of new impaired assets, and improve the allocation of capital by letting the market play a more prominent role. Allowing for more defaults by unproductive companies, and accepting a more realistic GDP growth target, would also put China on a more sustainable path. Implementing these actions will allow for a redeployment of investment along the lines spelled out below. Not implementing these actions in a timely manner will put longer-term growth at risk.