The FINANCIAL — Strong consumer spending, rising exports, and steady public spending are helping the world’s second largest economy maintain its growth momentum, but tax and other structural reforms are needed in the People’s Republic of China (PRC) for continued inclusive and sustainable development, according to a new report by the Asian Development Bank (ADB).
In its Asian Development Outlook (ADO) 2018, ADB projects gross domestic product (GDP) growth for the PRC to continue to moderate to 6.6% in 2018 and 6.4% in 2019, following last year’s exceptional 6.9% rate. ADO is ADB’s flagship annual economic publication.
“The PRC government is on track to meet its goal of transitioning the economy to a more consumption and services-driven one,” said Yasuyuki Sawada, ADB Chief Economist. “Comprehensive fiscal reforms, particularly with respect to income taxes and social security contributions, will help the country raise revenues to fund social services, address inequality, and enhance productivity.”
In 2017, services remained the main driver of growth, expanding 8%, compared with 7.7% in 2016, and contributing 4.0 percentage points to GDP growth. The services sector also kept the PRC’s labor market buoyant with 13.5 million new urban jobs created in 2017, above the government’s target of 11 million. Meanwhile, the industrial sector’s contribution to growth fell to 2.5 percentage points as industrial growth slowed to 6.1% from 6.3% in 2016 – part of the country’s continued economic rebalancing.
Falling food prices—especially for pork, vegetables, and eggs—led to a cooling of inflation. Consumer prices rose by 1.6% in 2017, down from 2% the year before, as food prices declined by 1.4%. Meanwhile, the implementation of real estate purchase restrictions in a growing number of cities slowed housing price increases. Bucking this trend were prices for services, which increased by 3% on the back of rising labor and education costs.
Consumption will again drive growth in 2018 due to high wage growth, rising consumer confidence, and higher government social spending. Investment, meanwhile, will continue its downward trend as real estate purchase restrictions persist while excess capacity and high debt will continue to limit investment in heavy industry. Consumer-oriented industries are expected to perform strongly in 2018. Inflation is projected to increase to 2.4% in 2018 and 2.3% in 2019 as food prices normalize, consumer demand strengthens, and price deregulation, particularly for healthcare, continues.
Looking at risks to the outlook, growth in the PRC could be negatively affected by lower commodity prices, which could dampen strong export demand from commodity producing countries; deteriorating global trade conditions, which could undercut PRC exports and investment; capital outflows resulting from rising US interest rates and a strengthening dollar; a continued slump in domestic investment growth; and sustained regulatory tightening, which could cause liquidity shortages. However, strong finances and government support puts the PRC’s economy in a good position to weather these risks.
The report discusses tax reform as a key policy challenge for the PRC government to address, serving as an opportunity to further raise revenues to help fund social services and reduce income inequality. Apart from addressing the issue of falling tax revenue and rising expenditure that have resulted in budget deficits, public debt, and contingent liabilities, fiscal reforms can also help strengthen labor market flexibility, productivity, and business competitiveness over the long-term.