China's rebalancing act

A recent shift in policy should keep China's economy moving, says Finbarr Thomas

The history books record the Great Leap Forward as having taken place from 1958 to 1961, but, in reality, the label has evolved into a tragic misnomer. The process of agricultural collectivisation and rapid industrialisation was catastrophic. Mao Zedong's policies over that time led directly to an estimated 40 million deaths in the Great Chinese Famine.

Looking at the leap

Perhaps those in the party's taxonomic department should have bitten their tongues in 1958. There's no doubt that China's greatest leap forward - at least in economic terms - has come in the past couple of decades.

Double-digit GDP growth was common for much of the 1990s and 2000s. As the west struggled to recover from the financial crash of 2008, China posted successive growth figures of 9.6 per cent, 8.7 per cent, 10.4 per cent, 9.4 per cent and 7.8 per cent up to 2012 (last year's return was a 13-year low).

One of the main propellers of China's modern growth has been state investment. This is best illustrated by considering the scale of some of the investments that have been made.

It used to take 24 hours to travel from Guangzhou to Beijing, but thanks to a 1,428-mile high-speed rail (HSR) line - the world's longest - the journey can now be done in just eight. The line took four years to complete and is part of a 10,000-mile HSR network China will have completed by 2020 at a cost of around £248 billion.

By comparison, HS2 - the planned HSR line linking London to Birmingham - will be 119 miles long and it's feared the overall cost will top £80 billion. It's estimated that it will take 13 years to complete.

And while Britain bickers over an extra runway at Heathrow or the proposed "Boris Island" airport on the Thames Estuary, China is committed to building 78 new airports by 2021.

Of course, nobody would wish the same level of development in the UK - China has more space, money, requirement and fewer environmental and social foibles - but the comparison shows the construction fever that's gripped China in recent decades and the decisive measures the government has taken to support it.

China has been simultaneously strengthening its hand abroad. From 2005 to 2010, China's FDI topped £200 billion. Its own astronomical growth spawned an insatiable appetite for raw materials: minerals and ores, metals and fuel. China's FDI has led to mining and energy booms everywhere from Australia to Chile, from Angola to Venezuela.

Those in the commodities trade learnt a new tune to dance to when China joined the World Trade Organisation in 2001 and have been rocking out to it ever since. The country's demand for oil, coal, cotton and iron has kept prices sky high.

The day the music died

Earlier this year, though, something changed. The music hasn't stopped, but it's certainly playing in a less buoyant key.

When Xi Jinping became president in 2012, he did so with the aim of achieving economic growth from domestic consumption rather than investment. It's a move that many have speculated about - and feared - for years but that is probably necessary in the long run.

The internet is littered with pictures of remote and sprawling cities covered with vacant skyscrapers, unoccupied hotels and vacuous train stations with dozens of terminals but serviced only by a handful of trains.

In 2011, China opened the world's longest sea bridge: the Jiaozhou Bay bridge, which links Qingdao on the coast to the island of Huangdao. At 26.4 miles long, you could run a marathon across it. But as the Financial Times wryly put it last year: "It's a success on at least one front: it has no delays. The problem is that it also has few cars."

While infrastructural investment is one of the most highly-regarded ways of stimulating an economy, too much can be inefficient. A train delivers nothing back into the economy if nobody rides it.

To compound matters, much of China's infrastructure boom was based on cheap credit, passed from the government to state-owned enterprises in the form of low-interest loans. It's been more difficult for private businesses to borrow, meaning they've often turned to unregulated lenders outside of the mainstream banking network - known as shadow banking.

China's shadow banking system is thought to have exceeded $6 trillion (about £3.8 trillion) in volume last year - but the figure is an estimate, since there is no reportage or transparency.

The government has no control over the flow of such capital and if not arrested, it's feared it could result in a housing boom - the liquidity in the market has to find a home somewhere and more often than not, it's in property. As we found out in the late 2000s, property booms can be disastrous for an economy.

Turning things around

Ironically for a nominally socialist country, the benefits of China's remarkable growth haven't been felt by most of its people.

Inequality is rife. Three hundred million Chinese people still don't have access to clean drinking water - almost the same number of people that live in the US. 13.6 per cent of China's people live on less than $1.25 a day, with almost 30 per cent making do on less than $2.

Beijing has realised that the next stage of its economic development should come through nurturing consumption among these citizens. By providing people with better jobs, more social security and better living conditions, you encourage them to invest back into the economy.

So how exactly does China manage this transformation? So far, there are two clear pillars of Chinese reform: improving living conditions and limiting the supply of cheap credit. When I interviewed her recently, Rain Newton-Smith, head of emerging markets at research firm Oxford Economics, told me that the government would change the mix of its spending.

"You'll see more direct transfers to rural households," she said. "At the moment to get access to social benefits such as healthcare, education and pensions you have to be an urban resident in what's known as the hukou system. You need an urban residence permit. We've seen a phenomenal rate of urbanisation; a lot of citizens are migrants from the countryside who don't have hukou status. One of the planks of reform is to widen access to this hukou system."

The government has also been issuing positive rhetoric about improving people's lives. Qinwei Wang, China economist at Capital Economics tells me that underdeveloped social infrastructure is likely to see more investment.

"Hospitals and schools will be built," he says. "The green economy linked to reducing pollution too will benefit from government policies. I've read local media reporting that the government wants to speed up green projects that will favour the environment and improve conditions."

And on the second pillar of its new policy, earlier this year the PBC announced that it would limit the amount of capital in the market in an attempt to deflate the ever-expanding construction bubble. Its main tool was to make borrowing more expensive by raising Shibor by almost a full percentage point.

And in July, Jinping, China's president, banned the construction of all government buildings for five years - a symbolic move, but one that demonstrated how determined the government is to change its course.

The fallout

When news of China's shift in policy broke, markets across the world panicked. Traders have become reliant on the People's Republic's demand for metals, minerals and energy. If China is to stop spending on vast infrastructure projects, then they in particular will feel the brunt of the blow.

"It's a shift in the story," says Wang. "Over the past decade if you're a commodity, steel, or copper producer you'll have been the biggest winner. Over the next decade there'll be a change - there'll be other sectors, such as medical, public manufacturing, social and consumption, that will benefit."

Furthermore, nations that saw huge investments from China in recent years may also suffer. "[The recent Chinese credit tightening] has been disruptive to emerging markets," says Newton-Smith. "It's clear that countries like Turkey, India, Brazil and South Africa have high current account deficits and are dependent on capital inflows from China to finance those. As capital is withdrawn we're seeing more volatility in markets and their growth is likely to be more impacted."

But as with most things in China, almost all watchers expect the shift to be managed carefully and with minimal fuss. As a partner at a leading political risk insurance firm told me recently: "While they're keeping a tighter control on liquidity they'll make sure there's sufficient liquidity in the system so that growth continues."

"With China it's always going to be a managed process. They have far tighter control over these things than other parts of the world."