Macroeconomic Monitor: Balancing Reform with Growth
As forecasters around the world scour China’s latest statistics for clues regarding the direction of China’s economic performance in 2014, China’s policymakers seek to steer the world’s second-largest economy on the road to reform and wean the economy off its decades-long reliance on often inefficient state-driven investment. In a similar manner in which a successful business regularly tweaks its business plan to stay ahead of the competition, China already has its master plan for change in place and the focus is now on execution. By Daniel Galvez
Today, the world is focusing on the implications of slower growth in China. Companies around the globe have been sluggish to adjust to China’s decline in economic growth and are scrambling to cope with constant changes in the global economic environment. Over the past decade, China poured money into building new factories, highways and apartment buildings, which propelled double-digit growth at home while giving commodity exporters favourable investment returns. Now the story is changing as China has targeted a modest growth rate of ‘around’ 7.5% for 2014, with many analysts interpreting the word ‘around’ as giving the government leeway if China does not meet its intended target by a few percentage points.
Anticipating a hairpin turn around the corner, President Xi Jinping and company have gently applied the brakes on the infrastructure-building boom to move the economy into a more consumer-oriented growth model. However, to depict just how hard this transition will be for China, capital formation actually accounted for 54% of China’s economic growth in 2013, exceeding consumption’s 50% contribution rate. Net exports detracted 4.4% from overall growth, sustaining a trend which began in 2009.
Growth has marched steadily downward over the past two years as Beijing clamped down on a spending boom which has pushed local government debt to now highly-publicised dangerous levels. Investment in fixed assets, which has been losing steam over much of the past year, will continue to decline in line with the government’s 17.5% growth target for 2014. Industrial production, retail spending and the housing market have all shown signs of weakness in the first quarter of 2014. All this translates into more volatile Chinese demand for a wide range of commodities. Moreover, China’s first corporate bond default in March sent a clear signal that the era of cheap credit is coming to a close. However, ahead of the release of first quarter GDP figures, China’s State Council did unveil a mini-stimulus package including additional spending on railways, housing for low-income households and tax relief for small businesses.
Competitive forces take hold
China’s total annual trade in 2013 reached over USD 4 trillion for the first time ever, overtaking the US to become the world’s largest trader. While first quarter figures are always difficult to interpret due to distortions caused by China’s weeklong Lunar New Year holiday, the latest economic indicators suggest that China is experiencing growing pains as it weans itself off of investment in order to attain more balanced long-term growth.
Tightened pollution regulations have made it harder for steel mills to use China’s low-grade iron ore reserves and for power plants to burn China’s low-quality coal. With the increasing focus on the environment and high costs in some industries, China is importing more of the key commodities they need.
While seeking to avoid overcapacity, Beijing will continue to encourage investment in innovative industries and infrastructure. Also, private capital is set to play a larger role. In a nod to Beijing’s latest efforts to reform SOEs and encourage a mixed-ownership economy, Sinopec, China’s largest oil-refining company, announced plans in February to open up its domestic marketing and distribution operations to both social and private capital.
Reform is real and here to stay
While three decades of breakneck economic growth has lifted hundreds of millions of Chinese out of poverty, it has also inflicted grave damage on the environment; China is now changing its strategy and aiming towards higher-quality development. Although the rate of economic growth slowed in 2013, business is still booming in China, and the new government is taking various measures to ensure that this continues.
The government announced its blueprint for change following the Third Plenum in November 2013, which promised sweeping changes to the economy and the nation’s social fabric – leading many to label it as China’s most ambitious reform plan in 30 years. Some of the hardest reforms, however, will require the government to break ranks with some of its traditional political allies, such as large SOEs.
Tackling pollution remains high on the agenda for the new administration. In 2013, China’s Ministry of Environmental Protection vetoed as many as 32 projects with a total investment of USD 19.5 billion and is feverishly working to improve its environmental assessment capabilities and strengthen its ability to monitor and punish polluters. Some other important economic issues that will be closely watched in 2014 include:
➢ Banks following through on soldier’s orders to cut off financing to sectors plagued by excess capacity such as steel and cement
➢ Management of shadow banking activities and local government debt levels before they can inflict widespread damage to the economy
➢ Continued rollout of Shanghai Free Trade Zone policies aimed at attracting a new wave of FDI
➢ Enforcement of property sector controls and the management of subsequent fallout if prices do eventually fall from their astronomical levels
➢ Accelerated liberalisation of China’s capital and foreign exchange markets, including the recent widening of the Chinese Yuan’s daily trading band, aimed at turning the Yuan into a major reserve currency
➢ The rise of private and online banking channels aimed at raising the overall competitiveness of China’s financial sector
The road ahead
While the emerging labour shortage and subsequent increase in wages are cutting into profit margins, investment returns and export competitiveness, it has increased household income. Higher wages improve income distribution as low-income households rely on wages and high-income households rely more on investment returns. Consumption’s share of GDP will rise as household income grows faster than national income. But this is only the beginning. Completion of this transition depends critically on Beijing’s implementation of the reforms announced at the Third Plenum.
If only a portion of the proposed Third Plenum measures are implemented, China will be well on its way towards becoming the world’s largest economy and boasting a thriving consumer market. Based on China’s success in navigating its economy through new territory, China’s performance for the whole of 2014 should be a cause for optimism.
Consultant; Editor: The China Analyst