have sharply reduced activity in officially designated “excess capacity” or polluting industries, such as coal and steel production. These cuts are likely to continue in the medium‐term. In February 2016, additional capacity reduction targets were announced for coal and steel and a fund was established to re‐employ or compensate affected workers. Capacity cuts were accompanied by other measures to strengthen SOE efficiency, including ten pilot programs for SOEs introduced in September 2015 and February 2016. Some provinces began in June 2016 to restructure unviable SOEs.

**Private enterprises: Falling returns.** Just over a third of the deceleration in private investment growth thus far in 2016 can be attributed to the slowing manufacturing sector (Qu and Wang 2016). Weakness in manufacturing investment reflects deteriorating business confidence and rising funding costs amid weak return prospects. Slowing export and domestic demand growth and persistent producer price deflation have weighed on return prospects. Between 2011 and 2015, the annual return on investment of private industrial enterprises has been estimated to have fallen by 3 percentage points to 8.5 percent, according to official data. Despite recent efforts to cut red tape, private enterprises still face high entry barriers, sales taxes, and surcharges by comparison with other countries in the region (Ernst and Young 2016).

# **Spillovers from China’s investment growth slowdown**

While the investment growth slowdown is an integral part of ensuring sustainable growth in China in the medium to longer term, it has had significant negative repercussions on activity both domestically, given investment’s large share in China’s GDP (about 43 percent in 2015), and globally because of China’s large role in the global economy. A slowdown in investment spills over to other sectors of the domestic economy through industry and financial linkages.<sup>37</sup> Since investment is more import‐intensive than other components of demand, adverse external spillovers from China’s investment slowdown have been particularly pronounced. For example, China imports large volumes of minerals and metals from countries in Latin America and Sub‐Saharan Africa (World Bank 2015a, c). Thus, about 40‐50 percent of China’s import growth slowdown from 2014‐15 has been attributed to weak investment (Kang and Liao 2016).

The GDP growth slowdown triggered by an investment slowdown can generate sizable cross‐border spillovers (World Bank 2016a; Huidrom, Kose, and Ohnsorge forthcoming). A structural vector autoregression model was estimated for 1998Q1–2016Q2 for 18 EMDEs to assess the magnitude of these spillovers. Details of the estimation are described in Annex 2C.

Since much of investment is resource‐intensive, the impact of an investment slowdown on commodity‐ exporting EMDEs is measured to be twice that on commodity‐importing EMDEs. A 1 percentage point decline in Chinese annual investment growth reduces output growth in commodity‐exporting EMDEs, on average, by 0.3 percentage point over the following year, about one‐third the impact of a similarly‐sized slowdown in overall output growth in China. In 2012‐15, slowing investment growth in China may have reduced commodity‐exporting EMDEs’ annual output growth by as much as 0.8 percentage point on average (Figure 3.2).

# **Policies to support an orderly rebalancing of investment**

A slowdown in China’s investment growth has been necessary to ensure sustainable growth. However, the concentration of the slowdown thus far in private investment raises concerns about growth prospects.

> 37For example, real estate investment in China, which accounts for 25 percent of FAI, has extensive industrial and financial linkages with other sectors of the domestic economy (Ahuja and Nabar 2012a).

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