Is China on a ‘German-Style’ Growth Plan?
Here are the marching orders: "China needs to cement its domestic economic growth momentum and guard against potential risks in financial sectors."
Thus spoke last Friday China's party bosses (Politburo Central Committee) in a clear, topical and timely message of measurable performance objectives addressed to the country's new government. The message captures two key issues: economic growth and stability of the financial system.
Growth has been brought down to more sustainable levels after two years of cutting inflation from 6.5 percent to 2.1 percent and fighting rampant property market speculations. Declining export growth from nearly 30 percent in 2010 to less than 6 percent last year has also tamed one of the powerful sources of aggregate demand.
In spite of that, with a growth rate of 7.7 percent in the first quarter, the economy still remains well within the official target range of 7-8 percent. The government, and the markets, can, therefore, take the message to "cement … economic growth momentum" as an invitation to stabilize the economy within that growth interval.
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Unless the new politburo members believe, as some observers do, myself included, that China can grow a bit faster because this target range is probably somewhat below the economy's noninflationary growth potential. That is the implied meaning of the consensus estimate for this year, which calls for a growth rate of 8.5 percent. Some official international organizations go even further by expecting significant growth acceleration to about 9 percent.
Both scenarios leave the Chinese government quite a bit of room to repeat its old "under-promise and over-deliver" routine.
Looking for Quality of Growth
In the meantime, here are two questions. First, can China step up the growth rate from its current level? Second, does China want to grow much in excess of its 7-8 percent target range?
The answer to the first question is an emphatic yes. China's monetary and fiscal policies have plenty of room to ease. Inflation at 2.1 percent is significantly below the central bank's target of 3.5 percent. The budget deficit is 2 percent of gross domestic product (GDP), and public debt is 22.2 percent of GDP, virtually unchanged over the past five years. The household debt stands at less than 30 percent of GDP.
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The answer to the second question is a qualified no. That is what transpires from the recent statements of policy intent by both the new prime minister and by the central bank's governor.
The emphasis in both cases is on stable and sustainable (noninflationary) growth. Prime Minister Li Keqiang recently spoke of the need to "improve the quality and benefits of economic development" as China seeks to reduce its reliance on exports, and to shift more resources toward domestic demand – household consumption, infrastructure and social welfare services.
A similar statement was heard from the People's Bank of China (PBOC) Governor Zhou Xiaochuan during his last week International Monetary Fund (IMF) appearances. He said that China's first quarter growth was "normal" and insisted that this year's growth target of 7.5 percent is in a range that will provide stable (read: noninflationary) economic environment for structural reforms.
Reforms are on everybody's mind. But it is an almost German-style sounding mantra from Berlin's Agenda 2010: Reforms in an environment of economic and social stability. China has to implement a vast program of reforms to develop a more competitive market economy, and to level the playing field for the privileged state-owned companies and the private sector firms in terms of market access and an equally fair treatment when competing for sources of finance.
The key feature of these reforms will be to give greater space to the private sector and free markets. Safer, more open and better regulated financial markets, capital account convertibility and a broader use of yuan in international trade and finance are all reform projects already under way.
On the fiscal side, China intends to reform and update its value-added system of taxation.
The PBOC's current investigations of suspected improprieties in the $3.7 trillion interbank bond market are just the latest example of how much the country needs a more effective regulatory and supervisory system to manage its financial services industry. That is also highlighted by the recent downgrade of China's long-term yuan debt – an event apparently motivated by an alleged lack of transparency in the borrowing of local governments.
Building Better and More Efficient Cities
This credit downgrade will probably make a contribution to the weeding out of "shadow banking" and other gray areas in China's financial markets. And if it is true, as the POBC Governor Zhou says, that capital account convertibility is the country's next big objective, then financial market reforms have to go much further, and to proceed much faster than currently thought.
Some of that increasing sense of urgency is of China's own making, because in the last few years Beijing moved to expand the yuan's role in cross-border trade. That has raised the share of trade conducted in yuan from less than 1 percent in 2009 to 9 percent at present. Similar results have also been recorded in financial transactions, especially in the area of yuan-denominated corporate bonds. At the moment, the yuan is ranked as the 13th major currency in international payments.
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Urbanization is another important aspect of China's reforms. It seems that this is Prime Minister Li Keqiang's key project. He vowed that urbanization will be the center piece of his government's agenda. One suspects that this is mainly because a huge and unrelenting influx of unemployed and underemployed rural labor force (estimated at about 400 million) into urban centers is straining the basic social services, such as housing, healthcare and education. Also, in spite of the fast growth of Chinese cities, the country's urbanization rate of 52.6 percent still remains well below developing world averages.
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This is an important point investment strategists should not miss: Building larger and more efficient urban centers (the French President Hollande was offering the "ville durable" or sustainable city concept in Beijing last week as one of his country's main export items) will require huge investments in infrastructure and social services. That alone could be one of the biggest sources of China's domestic demand in the years to come.
Indeed, China bulls may have a point. So far, China has shown that it knows how to operate a relatively stable and fast-growing economic system. Reforms that lie ahead are tough, but they are much easier than what China had to deal with in the past to set, and keep, the country on the path of record-breaking economic growth. And, unlike many other countries with similar needs and projects, China has the advantage of ample sources of internal funding.
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.