Posted on Wednesday, October 27, 2010
By Geoff Dyer
Published: October 27 2010
China’s economy is running into headwinds. Most governments in the developed world would love to have its problems, yet all the same, the country’s growth outlook is becoming more uncertain.
The authorities themselves were probably surprised by the country’s robust response to the global crisis, with growth reaching 11.1 per cent in the first half of the year on the back of a mammoth monetary and fiscal stimulus.
Yet the authorities have had to scale back the epic quantities of new loans that were issued last year to avoid a huge build-up in bad debt over the next few years.
And the export sector, which has shown surprising resilience during the downturn, will find it harder to keep up the high rates of annual growth, especially if growth falls again in the US and Europe.
None of this is a recipe for an immediate recession. But for many observers, the economy is reaching a point where its natural growth rate will drop well below the double-digit increases in GDP recorded over the past decade.
Jun Ma, an economist at Deutsche Bank, believes the potential growth rate will fall from 10 per cent during the past decade to 7 per cent in the coming 10 years. “The government’s target for GDP growth will need to be lowered over the next five years,” he says.
Two questions arise. Can the economy pivot quickly to find new sources of growth, notably from domestic consumption? And if there is a slowdown, how will the government respond?
Optimists have taken heart from the fact that for the first time in a number of years, consumption as a percentage of GDP grew last year. To some, this is an indication that the economy is beginning to move away from an excessive dependency on investment in favour of consumption.
The recent increases in wages, which won so much attention during a wave of strikes in southern China this year, will help boost consumption, even if they could also add to inflationary pressures.
“Private consumption is growing very quickly,” says Li Daokui, an economist at Tsinghua University and a member of the Chinese central bank’s monetary policy committee. “Chinese consumers are beginning to consume.”
Yet some economists believe that for consumption to play a much larger role in the economy, the government will have to make a concerted drive on a series of structural reforms that it has long discussed.
These include revamping the hukou system of urban registration that prevents migrant workers from settling in cities and becoming permanent residents and consumers. It would also involve charging companies more for energy and water, which would reduce incentives towards industrial investment.
Although there has been some movement on these fronts, more is required if they are to have a real impact on the economy.
“These issues will probably be mentioned in the next five-year plan but they have actually been on the policy agenda for quite some time,” says Paul Cavey, an economist at Macquarie Securities. “What matters now is whether implementation is speeded up.”
Financial system reform would also be another priority. One reason consumption is relatively low in China is the paltry levels of interest that households earn on their substantial savings – the result of a cap on deposit rates designed to boost bank profits.
Although there is pressure to relax restrictions on interest rates, the potential build-up in bad loans from the stimulus package could delay the introduction of such reforms, because regulators would feel the need to keep protecting the banks.
Should support for these reforms not materialise, the economy could run the risk of slowing below the 8 per cent goal that policymakers have set – raising the question of how serious these targets are.
There are some signs that the government is willing to forsake its growth targets. Since April, the government has been implementing a wide range of measures to try to cool the overheated property market, which has been one of the main drivers of growth in recent years.
At the same time, the authorities have stepped up a campaign to improve energy efficiency, with local governments ordering a string of inefficient factories to be shut down in order to meet tough targets set by Beijing for energy use.
However, not everyone is convinced that the authorities are so relaxed. Investors talk about the “Wen Jiabao put”, the idea that the Chinese premier will always intervene to pump up the economy if growth seems to be falling dangerously close to 8 per cent – which maintains high growth in the short term, but runs the risk of creating a large bubble in the medium term.
Arthur Kroeber at Dragonomics in Beijing says there is a risk the current senior leadership “will ride out its last two years on a wave of debt-financed growth”, leaving the politically difficult reforms for their successors.
If Mr Wen does not make a new push on reforms or push back on pressure to let debt levels rise further, says Mr Kroeber, “he risks being remembered as China’s Greenspan”.