Thursday, April 24, 2014
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Li Keqiang’s Bottom Line

SHANGHAI – Everyone is talking about China’s economic slowdown. Last year, Chinese GDP growth reached a 13-year low, and no upturn is in sight. But, as Premier Li Keqiang seems to recognize, this trend could actually be beneficial, spurring the structural reforms that China needs to achieve its longer-term goal of more balanced and stable GDP growth.

Recent assessments have offered a downbeat picture of the world’s second-largest economy. In its latest Global Economic Prospects report, the World Bank cut its 2013 economic growth forecast for China from 8.4% to 7.7%. Moreover, recently released central-bank data show that Chinese banks increased their lending by only about ¥667 billion ($108 billion) in May – a roughly ¥125 billion decline from the same period last year.

But simply lending more would not improve the situation. Given that outstanding loans already amount to nearly double China’s GDP – a result of the country’s massive stimulus since 2008 – new loans are largely being used to pay off old debts, rather than for investment in the real economy. Thus, the more relevant concern is that the balance of outstanding loans has not risen.

In recent years, tight monetary policy and increasingly strict controls on the real-estate sector have caused the growth rate of fixed-asset investment to fall, from more than 25% annually before 2008 to around 20% today. Furthermore, the growth rate in China’s less developed eastern regions amounts to less than half of the national average. As a result, growth of industrial value added – which contributes almost half of China’s GDP – is slowing even faster, from an average annual rate of 20% during China’s boom years to less than 10% in 2010-2012 and just 7.8% in the first quarter of this year.

The key to restoring China’s GDP growth is, therefore, returning fixed-asset investment growth to at least 25%. With a new round of stimulus, China’s excess production capacity and underused outlays (for example, built-up real-estate assets) could be mobilized immediately, restoring 9% annual GDP growth.

But the willingness of China’s new leadership to initiate another round of growth-securing stimulus depends on what rate of GDP growth Li can tolerate. With China’s leaders having offered no indication that they will change current monetary policy, some economists have estimated that Li will not act until GDP growth falls below 7%.

The reason for Li’s inaction emerged in early June, when Chinese President Xi Jinping told his American counterpart, Barack Obama, that China had deliberately revised its growth target downward, to 7.5%, in order to pursue structural reforms aimed at supporting stable and sustained economic development. Given that China was moving toward such reforms before the 2008 global economic crisis prompted former Premier Wen Jiabao to launch his ¥4 trillion stimulus plan, Xi’s statement suggests that the new government will seek to restore the economy’s pre-2008 fundamentals.

In 2005, China was experiencing currency appreciation, which, as other fast-growing economies in East Asia have demonstrated, can stimulate the government and businesses to pursue structural reforms and industrial upgrading. But the subsequent increase in official fixed-asset investment – which rose by 32% in 2009 alone – delayed structural reforms, while over-capacity and a real-estate bubble became even larger and more deeply entrenched problems.

The government must now dispel the remaining vestiges of the stimulus-fueled over-investment of 2008-2010, however painful it may be. This means allowing the economy to continue to slow, while maintaining relatively tight macroeconomic policies that force local governments and the business sector to find new sources of growth.

The combination of external shocks and internal pressure from rising wages can serve as a powerful incentive for governments and businesses to pursue structural reforms. For example, firms in China’s export-dependent coastal regions have been burdened by renminbi appreciation since 2004. When the economic slowdown hastened the relocation of many manufacturers to inland provinces or neighboring countries, those in the coastal regions began to call for increased openness, deeper structural reforms, and industrial upgrading.

The view that Li will tolerate slower growth only above a particular threshold is based on the belief that GDP growth below 8% would hurt economic development more than it helped, and lead to social instability. And, indeed, if unemployment pressure had become as acute today as it was in the 1990’s, the prolonged economic slowdown would undoubtedly have precipitated government intervention.

But, over the last decade, structural changes to China’s economy have caused unemployment pressure to decline significantly – a trend that can be corroborated by across-the-board wage increases. Now, the setting is very favorable to build the stronger, more stable economy that Li wants – and that China needs.

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  1. Portrait of Pingfan Hong

    CommentedPingfan Hong

    "Slow growth is good for economic structural change", "high investment delays structural reforms", I don't understand how economists could reach such conclusions.

    A slowdown in growth may be a sign for the needs of economic change, but a slow growth is neither necessary nor sufficient condition for a successful economic structural change.

    Moreover, structural changes in an economy would require more, not less, investment in the new leading sectors.

    The problem is not the high investment rate, but where the investment goes.

  2. CommentedJonathan Lam

    Gamesmith94134: Li Keqiang’s Bottom Line
    After reading Mr. Roubini’s “De-risking revisited” I realize the slow growth in the EMN, and it even happened in China. “While risk aversion and volatility were falling and asset prices were rising, economic growth remained sluggish throughout the world. Now the global economy’s chickens may be coming home to roost.” The concept of perpetual growth would end if the QE ceased. Perhaps, many would have shocked by the China Commercial Bank’s announcement on the 90days products at 5.5%; or the 6 trillion shadow banking off the balance sheet may turn off the credit and loan industry. "prominent risks are not only in the shadow-banking area but also in local government financing vehicles, and we do need to be on high alert," Vice-Minister of Finance Zhu Guangyao said in Beijing on Friday, Zhu said.
    Perhaps, the present danger of the fixed assets and ETF management may face with half full or half empty based how each economy is reacting to the availability of cash flow or each central bank may limit itself in. In the process, the equitable verses the pyramid scheme will consequently fall on both inflation and deflation, it depend on the sources of financial and local developments. For the outlook on the Li’s ten points view on the finance and his micro economical stand, it contrasts with the ECB’s 0.5% interest rate unchanged; I felt the polarization at the coming chicken comes home to roost. At the marginalization on the 7-9% growth, many insurer and pensioner like us would have a tougher choice which home is coming to roost; but, given the beneficial another chance to breathe, I would certain the prospectus on the growth will lead its way.
    I would agree with Mr. Zhang’s view on the downscaling pricing on Real estate and earnings on industrial valued added from the macro economical standpoint; even though the outflow on the cash will definitely affect the deflation or disinflation as to the pricing on the real estate and more local governments and the business sector have to find new sources of growth. Perhaps, I am looking forward on the micro-economical view that Mr. Li can hold on his ten points to reform the financial system. Apparently, it would be more political pressures too when the ECB and FED may sustain their paths to restructure.
    If Mr. Li’s bottom line is between 7-9% in growth, I think I am getting the relief for my pension invested in China; and I think IMF or World Bank should weight on the sovereignty’s right or look on the micro-economical standpoint that all interest rate operates marketwise would be best on the reality to its reform, instead of being the piper who lead to the rift. Stand fast….
    May the Buddha bless you?

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