15 June 2014
by Yiping Huang,
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.