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The economy, which is driven by credit expansion, especially from the real estate and state-backed infrastructure projects, suggests that  it is still in a critical period of transformation. The picture shows South-to-North Water Transfer Project.
The economy, which is driven by credit expansion, especially from the real estate and state-backed infrastructure projects, suggests that  it is still in a critical period of transformation. The picture shows South-to-North Water Transfer Project.

China Passing Through a Period of Transition

As trade protectionism becomes prominent, the government will have to rely on higher spending and massive bank lending to support the economy

China Passing Through a Period of Transition

While it remains a challenge to understand the headline growth in China, one can conclude the economy is slowing.
For the past six years, Chinese economic growth has eased from a high of 10.6% in 2010 to 6.8% in 2016. In fact, the country registered the slowest growth since 1990 in 2016. It is a clear indication that the economy is going through a period of transition, moving away from the traditional industries to a consumer-led economy with services now accounting for 51% of the GDP, The Star Online reported.
With uncertainty clamoring from both the domestic and external fronts, headwinds on its economic performance remain. Furthermore, as trade protectionism becomes prominent, the economy will become more dependent on domestic demand. The government will have to rely on higher spending and massive bank lending to support the economy.
Such shift in policy adds risk of potential inflationary pressure, especially the consumer inflation which is poised to increase.
Part of the increase would come from rising producer prices which jumped to an unexpectedly high level of 5.5% based on annual change in the month of December 2016 driven by higher coal, steel and metal prices as well as from the weak yuan. Higher producer prices will eventually force businesses to transfer prices to consumers, either partially or in total.

  Multiple Concerns 
The economy, which is driven by credit expansion, especially from the real estate and state-backed infrastructure projects, suggests that it is still in a critical period of transformation with the old growth drivers yet to be replaced by the new ones. Thus, the risk of state-led investment crowding out private sector investment will potentially pull down the future returns on capital.
Furthermore, the economy was hit with huge outflow of funds. In 2016, net outflow of funds amounted to $304.9 billion, which translates into monthly average of $25.8 billion, the largest annual amount data since 2010. With such huge outflow of funds, the authorities introduced selective measures.
Among the measures was the prohibition on lenders from processing cross-border yuan payments until inflows and outflows were balanced. Besides, the lenders are required to examine the use of the funds overseas. Other measures include placing restrictions on mainland companies’ purchases of offshore assets while making it difficult for residents to buy insurance in Hong Kong.
It appears that these selective measures are kicking in well. In December, only $900 million worth of yuan left China compared to $33.3 billion in November.

  At Crossroads
With the economy becoming more complex, the risk of it heading to a crossroad is glaring. Pressure on the economic performance in 2017 will come from issues like a cooling housing market; structural reforms by the government; measures to address supply shortages in the commodity sector, which will likely weigh on demand and output; and potential impact from the (US President Donald) Trump administration.
Hence, for the authorities to keep the growth momentum around 6.5%, the country’s debt ratio to GDP should rise from 250% in 2015 to around 270%-280% in 2017 and probably touch 300% by 2018 or even higher. This can have serious repercussions.
There will be pressure on the yuan to weaken further especially if the growth is being fuelled by debt. And there is some risk that the central bank may experience some limitation to prop the yuan with its foreign exchange reserves.
A rapid decline in foreign exchange reserves could become counter-productive especially if it raises concern about reserve adequacy and intensifies yuan depreciation expectation and capital outflows. 
Meanwhile, the recent measures by the government to crackdown on capital outflow that caused the yuan to fall by its fastest pace since 1994 may slowdown the process for the Chinese stocks called “A shares” gaining entry into the MSCI Emerging Markets Index and be fully included in global benchmarks.

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