Kavan Choksi Discusses Why It is Unwise To Underestimate China’s Economy

For more than two decades, the exceptional economic performance of China had both alarmed and impressed a good part of the world, including its top trading partner the United States. Kavan Choksi points out that since 2019, however, the sluggish growth of China has led many observers to conclude that China has already peaked as an economic power. This is largely due to the weak household spending of the country, its entrenched deflation and its declining private investment. Many believe that instead of overtaking the USA, China may even end up entering a long recession. However, this dismissive view of the country underestimates the resilience of its economy.

Kavan Choksi talks about why the world’s second-biggest economy should not be underestimated

In the recent years, China has experienced multiple well documented headwinds. The challenges faced by the country included a shrinking working-age population, including a housing market slump, as well as restrictions imposed by the United States on access to some advanced technologies. However, one must also recognize that China managed to overcome much greater challenges when it set out on the path of economic reform in the late 1970s. Even though China’s growth has slowed down recently, the country does have the capacity to expand at a rate greater than the USA in the years ahead.

There are many misconceptions surrounding the pessimism about the economic potential of China. A widely held misconception is that the Chinese economy’s progress in converging with the size of the United States economy has stalled. GDP of China did fall from 76% of U.S. GDP to 67%, that from 2021 to 2023. However, it is vital to also take into account that by 2023, the GDP of China was 20% bigger than it had been in 2019, the eve of the global pandemic, while the United States’ was just 8% bigger.

As Kavan Choksi says, this apparent contradiction can be explained by considering two key factors. Firstly, in recent years, inflation rates have been lower in China compared to the United States. For instance, last year, China’s nominal GDP expanded by 4.6%, which was lower less the 5.2 % that its GDP grew in real terms. However, in case of the United States, due to high inflation, nominal GDP in 2023 grew by 6.3 %, while real GDP grew just by 2.5%. Secondly, the U.S. Federal Reserve has raised interest rates by over five percentage points since March 2022, from 0.25% to 5.5%, thereby boosting the value of the dollar relative to alternative currencies and making dollar-denominated assets more attractive to global investors. On the other hand, the central bank of China cut its base interest rate from 3.70% to 3.45%. The increasing disparity in interest rates between China and the United States reversed what had been a large inflow of foreign capital into China.

However, these two factors are likely to be transitory. The United States interest rates are now declining relative to rates in China, and as a result, the depreciation of the Chinese currency has begun to reverse. The IMF or the International Monetary Fund forecasts that Chinese prices will pick up this year.