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COLUMN-China battling wrong 'convergence': Mike Dolan

·5 min read

(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own)

By Mike Dolan

LONDON, June 2 (Reuters) - China remains on course to be the world's biggest economy this century, even if only briefly, but real convergence of living standards with richer powers is harder and brings other financial headaches.

In what appears like a hyperactive period for China's authorities, Beijing announced on Monday it would allow families to have up to three children - a surprise move just 5 years after it abandoned the long-standing "one child" policy largely responsible for the country's dramatically ageing population.

The trigger was last month's once-in-a-decade census showing the population grew at its slowest rate since the 1950s in the 10 years through 2020 and could be shrinking by 2025. With a fertility rate of just 1.3 children per woman in 2020 - far below the 2.1 "replacement rate" - China's is already on par with ageing societies such as Japan and Italy.

That's clearly not the convergence China's leaders have in mind and stresses the oft-repeated warning that China's 1.41 billion population may get old before it gets rich.

China is already comfortably ranked as the world's second biggest economy, with more than $16 trillion in annual gross domestic product. But it's simultaneously ranked number 61 by the International Monetary Fund in GDP per capita - still behind the likes of Romania or Uruguay.

While global demographic studies reckon China could surpass total U.S. GDP levels within 15 years, they also indicate that dire demographic trends will see it lose that lead position again by the end of the century.

And there is scepticism a three-child move will make much difference. The apparent failure of Beijing to shift the dial much with its move to a two-child policy in 2016 raises questions about how much it now needs to spend on housing and childcare to encourage bigger families.

By some estimates, it would need to be spending up to 5% of GDP more annually on these areas to even match western standards on that level.

While retirement ages are to rise too, many also point out risks of a potential pushback against women in the workforce and other social discriminations.


Should investors care about this right now?

Demographic trends seem glacial to often myopic financial markets. But they also clearly have profound implications for China's growth potential, its ambitions for economic power and security and savings and investment policies.

And while there are myriad moving parts in China's emergence as pivotal world economy and embrace of overseas investment, the demographic question is potentially important for foreign funds currently lapping up Chinese sovereign debt.

Morgan Stanley estimates that while there was some $121 billion of foreign outflows from Chinese equity since the start of last year, record foreign inflows to Chinese bonds of some $215 billion more than offset that.

At 3%, China's 10-year government bonds currently offer more than 140 basis points over U.S. Treasuries and about a percentage point more than any of the equivalent G7 sovereign bonds.

Together with huge trade and current account surpluses over the past year - as China bounced back quickly from the COVID-19 pandemic that originated there - upward pressure on the exchange rate has built up steadily from the net capital inflows.

In the 16 months to April, dollar deposits at Chinese banks rose by $242.2 billion, People's Bank of China data showed, a rise equal to about 1.8% of gross domestic product.

That pressure has seen the offshore yuan appreciate more than 10% over the past year, breaking to its highest since 2018 late last month and prompting a flurry of PBOC moves to slow its rise - including Monday's hike in the foreign currency reserve requirement by two percentage points to 7% from June 15.

Of course, the cat-and-mouse game between the PBOC and yuan exchange rate, which periodically includes a U.S. Treasury worried about trade-related currency manipulation, has been going on for many years and will likely continue.

But if China can't arrest the demographic greying, the wrong sort of convergence with Japan, Germany and Italy may come quicker than it would like - certainly quicker than any catchup with per capita income levels.

For investors in those three key G7 government bond markets, the 200 basis point spread may continue to be too hard to ignore - especially if short term currency appreciation is into the bargain and demand for the two feed off each other.

Already worries about a lack of 'safe assets' has seen spillover of private investors from euro zone and Japanese government bond markets - where net new bond sales are all being vacuumed up by respective central banks in asset purchase schemes - and into U.S. Treasuries and to some extent Chinese government bonds too.

Whether this week's moves signal Beijing's determination not to allow demographics to deteriorate further, or merely just underline the issue remains to be seen.

"The Great Convergence is not just about the eightfold increase in per capita income since 1980 but also in fertility rates," said Bannockburn Global Forex strategist Marc Chandler, adding that "urbanization, modernity and legal equality are powerful prophylactics."

(Reporting by Mike Dolan; Editing by Chizu Nomiyama)