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Economic Research: The Case For Cautious Optimism On China's Rebalancing And Openness


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Economic Research: The Case For Cautious Optimism On China's Rebalancing And Openness

Beyond the immediate economic boost from China's reopening, lies the potential for larger shifts. The next few years should reveal whether setbacks in China's economic rebalancing and openness are temporary, or intractable. We are cautiously optimistic but see risks, especially regarding rebalancing.

The rebalancing process toward a larger role for consumption and services stalled in the mid-2010s and even reversed in recent years. And, after having grown in line with the economy for decades, imports started to lag in the mid-2010s. In both areas, developments were particularly unfavorable in 2022.

These trends have led to worries about the outlook for rebalancing and the possibility that China is "turning inward," with the rest of the world not nearly benefiting as much from the country's future growth as it did in recent decades. In annual National People's Congress (NPC) meetings that took place in China last week authorities spoke of "self-reliance"--is this another sign of insularity?

What To Watch For: Data And Policy

Our analysis suggests a few specific factors have weighed on rebalancing and imports in recent years, most importantly COVID. We expect rebalancing and the vigor of "normal" imports to resume, helping to assuage concerns about the pattern of growth and of China turning inwards. By normal imports we mean those used in the domestic economy instead of in the processing sector.

But it's hard to be certain about the trajectory after the initial bounce-back in 2023. Several factors are pulling in opposite directions as to rebalancing and import strength. Maintaining momentum in coming years will require further reforms, including a consumption-heavier design of stimulus policies.

On the import front the coming years will show to what extent China's policymakers can avoid protectionist and decoupling-oriented policies amid (1) global headwinds to globalization and (2) efforts by the U.S. and other countries to decouple parts of the economy from China.

Judged by the focus of recent high-level policy documents and statements, including the NPC work reports, we see larger risks of rebalancing proceeding slowly than of China turning inwards.

Rebalancing's Setbacks And Potential

The role of consumption and services in China's economy has declined in recent years, setting back the rebalancing process. In the mid to late 2000s, China's policymakers started to try to shift the growth pattern, introducing a range of reforms. The country's intensely investment- and industry-heavy mode of growth had successfully supported rapid growth and reduced poverty. But it had also led to relatively low consumption, environmental degradation, and heavy reliance on energy and commodities.

Progress was made in the 2010s with raising the role of consumption and services while reducing the reliance on investment and industry (see charts 1-2). However, since around 2015 progress stalled in increasing the role of consumption. This was in no small part because of policymakers' tendency to respond to recurring downward pressure on growth with investment-oriented stimulus packages.

Chart 1


Chart 2


These trends were amplified during the pandemic. Consumption and the service sector were hammered by heavy mobility restrictions and social distancing.

Meanwhile, industrial production largely held up amid strong efforts to minimize production disruptions in industry by companies and local governments, including on "defending China's role in global supply chains". Indeed, China's exports performed well during the pandemic; their global market share rose between 2019 and 2022.

Is The Import Weakness Temporary Or Structural?

After growing at least as fast as GDP in the 2000s and early 2010s, real overall imports (as in, corrected for price changes) started to lag the economy around 2015 (see chart 3).

However, there are a few specific factors at play that have weighed on imports recently. Taking them into account nuances the picture substantially and suggests that, with its economy recovering from COVID and people allowed to travel again, normal imports should pick up considerably this year.

Imports have been weighed down by the declining importance of the processing sector, where imported components are assembled and re-exported. This sector grew fast after China's WTO accession in 2001. At its peak, in 2006, processing imports were 46% of the total. [1]

As the country's manufacturing sector moved up the value chain, the share of components that could be sourced within China, rather than imported, rose. This, combined with steady wage growth, has reduced the relative attractiveness of the processing sector, even as other exports expanded. Indeed, processing imports have stalled since the Global Financial Crisis and in 2022 they made up only 26% of the total.

Meanwhile, normal imports continued to broadly track domestic demand until around 2018/2019, with both expressed in real terms (see chart 4).

Chart 3


Chart 4


COVID and the policies to fight it had a drastic impact on the economy in various ways. Normal goods imports were not significantly affected until 2022, when major disruption from pandemic measures and a property downturn kicked in. However, the virtual suspension of outbound tourism because of government restrictions led to a steep fall in overall services imports. Our estimate of real normal goods imports (see chart 5) tracked domestic demand reasonably well through 2021. The estimate excludes both processing imports and services imports.

That even real normal goods imports fell sharply in 2022 indicates how weak and hampered economic activity was amid widespread lockdowns last year. Together with resilient exports, the result was an increase in the current account surplus. That made China the only major manufacturing exporter that saw its external position improve last year despite a major worsening of the terms of trade amid sharply higher energy and commodity prices (see chart 6).

Chart 5


Chart 6


Earlier Trends Should Resume, But To What Extent?

The coming years should reveal to what extent COVID is to blame for changes in China's medium-term trends, and to what extent they are more long-lasting.

The post-COVID recovery will be led by consumption and services and result in GDP of around 5% in 2023 (see "China's Earlier Policy Shift Advances Its Recovery," published on RatingsDirect on Jan. 18, 2023). While real estate activity rose faster than expected in early 2023, the recovery is likely to be more modest than previous ones, given the more restrained policy stance and demographic transition.

Meanwhile, manufacturing investment will be dampened by the subdued export outlook. This type of growth is likely to aid rebalancing toward a larger role for consumption and services.

The growth acceleration should also lead to a resumption of growth of normal import volumes. The consumption and services-oriented nature of the pick-up in economic growth that we expect will limit the impact on imports, since that type of domestic demand is less import-intensive than investment. Also, processing imports are likely to be weighed down by subdued global demand and efforts by multinational firms to adjust supply chains.

Over the long term, processing trade is likely to continue to diminish in importance, as firms adjust global supply chains, reducing the reliance on China. This means that processing imports will remain a drag on overall imports.

But outbound international travel and services imports should recover strongly this year, boosting services imports. And, following the initial bounce back, growth should become more broad-based, with investment and industrial activity also contributing meaningfully to growth.

In all, rebalancing and growth of normal imports are likely to resume this year. But, with several factors pulling in opposite directions, it is only possible to be confident about sustained rebalancing and openness after the initial bounce-back in 2023 if there is decisive policy reform.

Maintaining convincing rebalancing momentum will require further rebalancing-oriented reforms, including a more consumption-oriented design of stimulus policies. However, policies to raise the role of consumption have not been a major policy focus recently.

As to the plans for 2023, the Work Reports of the Premier and the National Development and Research Commission submitted to the National People's Congress in March called for boosting consumption. But they did not announce major policy measures on that front even as they discussed various plans to increase investment. We will need to see how policy will evolve in this area in coming years before becoming more confident on this front.

On the import side the coming years will show to what extent China's policymakers will avoid "self-reliance" and decoupling-oriented policies amid global headwinds to globalization and efforts by the U.S. and other countries to decouple parts of the economy from China. The Government Work Report emphasized national security and self-reliance "amid a fast increase in external containment". But it also called for further opening up to the global economy by:

  • "expanding market access";
  • "ensuring national treatment for foreign-funded companies";
  • "taking action to see China joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership";
  • "acceding to other high-standard economic and trade agreements"; and
  • "leveraging the role of imports and exports in driving economic growth."

In our view, this confirms the commitment to opening up the economy that we see as remaining a key plank of China's development strategy (see "China's Trend Growth To Slow Even As Catchup Continues," Nov. 9, 2022). It is in line with our view that, despite decoupling challenges, China is unlikely to turn inwards. Given the impact from re-opening after the pandemic and this policy stance, we expect 'normal' imports to expand solidly in coming years.

In all, we see larger risks of rebalancing proceeding slowly than of China turning inwards.


[1] Amid a lack of an exact definition of processing trade we use a broad and a narrow definition. We report the average of the two.

Related Research

This report does not constitute a rating action.

Asia-Pacific Chief Economist:Louis Kuijs, Hong Kong +852 9319 7500;

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