The latest Markit Business Outlook survey has indicated that there is renewed confidence in the economy as sentiments have risen to a 2-year high. The optimism tilts towards the manufacturing sector, as firms forecast a higher output in the year ahead. The upshot of this is that companies are anticipating higher business revenues, which is an increase of 17% from October. This in turn forebodes improved business conditions across China, both in the manufacturing and services sector. This environment obviously sets up the precedent for capital expenditure by Chinese firms, which is expected to climb to +13% in autumn, and the highest level since October 2014. Annabel Fiddes, Economist at HIS Markit has commented, “Projections of stronger growth in the next year coincide with forecasts of strengthening inflationary pressures. Furthermore, both input costs and output charges are expected to increase at the quickest pace in four years. Price rises look set to be stronger at manufacturers, who are particularly vulnerable to price movements for energy and commodities.”
While the above numbers delineate one side of Chinese economy, the warning signal to be borne in mind is that China debt to GDP ratio stands at 250%, of which corporate debt itself is 170% of the GDP, which speaks of a highly leveraged and a debt fueled economy. The country rather than dialing back its credit-fueled growth model, has continued to support credit driven expansion to meet its GDP growth target rate targets. Over the recent past, a lot of credit was injected into the state-owned sector while investment in infrastructure has continued. Critics have cited their concern of this fundamentally unsustainable growth model with its heavy reliance on debt weighted investments funding an export drive which increases default probability. In an effort to reorient the economy to sustainability, Chinese lawmakers are emphasizing a shift towards to technologically driven innovative model which would add more value to the economy. In time, this would also enable China to overcome a middle-income trap that it finds itself trapped. To recalibrate the economy, lawmakers realize the need to emphasize on technologically driven innovation that would allow higher capital gains allowing the common man to raise his disposable income allowing for an overcoming of the a middle-income trap; approaching Western Europe or the United States, where innovation has allowed these economies to make leaps and bound. However, it is to be borne in mind that it is difficult to incubate innovation, in an environment lacking proper institutions supporting growth. It is the really the relative lack of these institutions which is deemed an obstacle for the Chinese growth model and a challenge to be overcome by its government.