15 June 2014
by Yiping Huang,
Peking University.
In
mid-April, China’s National Bureau of Statistics reported real GDP
growth during the first quarter at 7.4 per cent, marginally below the
official target of 7.5 per cent for 2014. During a recent lecture with
35 branch managers of a leading joint-stock bank, I conducted a small
survey by asking for their assessment of the reliability of the
first-quarter GDP data. All of them believed that it was significantly
overstated. In fact, most businessmen and economists estimate the actual
GDP growth to be between 1 and 2 percentage points below the official
figure during the first quarter.
Perhaps
this explains the high degree of anxiety among officials when economic
data weakened visibly in February and March. As a result, the government
took steps, often described as mini-stimulus or targeted easing, to
stabilise economic growth. These include increases in financing and
investment in areas such as high-speed rail, urban housing, new power
plants, and so on.
But doesn’t this reaction raise a question about how serious the government was when it argued in favour of tolerating slower growth and accelerating economic reform?
Although
the government lowered the growth target to 7.5 per cent — from 8 per
cent previously — it is still quite reluctant to let growth slip below
its new target.
Although the official GDP
growth figure for 2014 will likely be around 7.5 per cent, all of the
economic momentum points downward. Export growth will probably be very
modest, because the US economic recovery has been weaker than expected
and the Chinese export sector is undergoing major restructuring due to a
rapidly rising cost base. The upward trend in consumption should
continue as rapid wage growth lifts household income, but public
consumption may remain soft as a result of the government’s
anti-corruption drive.
Fixed asset
investment is still the main area in which the government acts to
stabilise growth. But weakening market conditions in the property sector
mean the outlook is not encouraging. Manufacturing investment should be
relatively stable given the outlook for exports and consumption. The
central government may increase infrastructure investment if the economy
weakens again, but there is little room for local government action in
this area because of a decline in revenue from land sales and the
tightening in financing conditions for local government investment
vehicles (LGIVs). Recently, the central government started an experiment
allowing ten provincial governments to issue local government bonds.
In
addition, a recent International Monetary Fund (IMF) study estimates
that if the comprehensive reform program approved in November is
rigorously implemented, it could reduce Chinese GDP growth by 0.2 of a
percentage point in 2014 but boost growth by more than 2 percentage
points in 2020. While it is probable that the short-run negative impact
will be greater and the medium-run impact more modest, the overall point
stands: short-term pain will result in long-term gain.
While
there are downside risks for economic growth, the government is being
overly cautious. Officials often warn against three potential problems
of growth below 7.5 per cent: increased unemployment, financial
instability and a loss of investor confidence. But these arguments are
not well-supported by facts. The greatest fiction in policy discussion
today is the need for 12 million new urban jobs every year. This is
exactly the same number that was given 16 years ago when the government
first proposed the need to maintain an 8 per cent growth rate. At that
time, the labour force was rising by 8 million a year. Now it is falling
by 3 million a year. But as officials and economists worry about the
impact of the growth slowdown on employment, labour supply is actually drying up, with wages continuing to rise rapidly.
The
potential impact of a growth slowdown on financial instability is more
difficult to assess, given the gigantic size of the shadow banking
sector, massive LGIVs liabilities and growing non-performing loans in
the banking sector. However, all these activities are linked to the
state, one way or the other. This is why, if China suffers from major
financial instability problems in the near term, it will be because of
reduced liquidity rather than a loss of capital. Financial stability is
tied to the fact that everybody relies on the central government’s
fiscal capacity. The problem with China’s financial system is therefore
one of flows, not stocks.
The impact on
investor confidence is even harder to figure. At the end of last year,
most investors actually favoured a lower growth target because that
would send a stronger message about the government’s determination to
push ahead with reform. Look at how the domestic A-share market has
performed and it is obvious that investor confidence has been weak for
quite some time.
Recently, the government
accelerated its pace of implementing wide-ranging economic reforms. It
looks like the government will be able to push ahead with reforms more
quickly in areas of reducing administrative controls, liberalising the financial system
and reforming factor prices, but more slowly in areas of land reform
and restructuring of state-owned enterprises. These reforms should
eventually lift China’s GDP growth potential by improving resource
allocation and supporting productivity gain. However, in the near term,
growth will likely weaken further before it picks up.