posted on 21 August 2016
by Dan Steinbock, Difference Group
Assuming no surprises in the second half of the year, China's growth in 2016 will remain near the target of 6.5 percent reflecting structural transition in the mainland, secular stagnation in the West and post-Brexit tensions globally. Graph below showing China growth rate from1995 through 2013 is from Blue Note.
In mid-July, China's second-quarter GDP figures beat estimates with a 6.7 percent expansion, thanks to support by a slate of stimulus measures from the government and the central bank.
In the next two quarters, China's growth is expected to decelerate to around 6.5 percent or less. In annualized figures, the quarterly data indicates an expansion of nearly 6.5 percent, which remains close to the ambitious target of 6.5-7 percent. At the same time, the consumer price index (CPI) is likely to increase to 2.5 percent.
Diminished global prospects
Since early spring, policymakers have opted for fiscal and monetary stimulus, particularly to support property markets which have fueled home prices, while contributing to construction, employment and stability.
However, the central government is between a rock and a hard place, thanks to diminished global prospects.
In the US, fiscal conditions have tightened and rate hikes remain on hold. In Europe, expansion relies excessively on central bank's quantitative easing and ultra-low rates. In Japan, Prime Minister Abe is pushing still another huge fiscal stimulus, while central bank is relying on negative rates and aggressive monetary injections.
In this international comparison, the People's Bank of China (PBOC) looks almost conservative as it has allowed the deflation of some asset bubbles. Nevertheless, while the PBOC may not resort to policy rate cuts, it is likely to engage in further cuts of reserve ratio requirements (RRR), which will reduce the amount cash banks need to hold.
As a result of leverage, Chinese banks' non-performing loans (NPLs) have increased, while concerns have risen about asset quality, due to credit expansion.
Beware of sustained credit expansion
Between 2007 and 2014, debt-to-GDP ratios rose in major advanced economies, by more than 50 percentage points in many cases. During the same period, China's debt quadrupled to $28 trillion, fueled by real estate and shadow banking.
In the advanced West, accumulated debt will constrain growth for decades to come. Despite relatively faster debt accumulation, China may be better positioned to overcome credit expansion.
Unlike major advanced economies, China can still manage its debt on the back of growth. In the US, government debt exceeds 105 percent of the GDP, while below 2 percent growth is not adequate to contain the challenge. What's worse, Washington lacks a credible, bipartisan and medium-term debt plan. In the Euro area,
government debt exceeds 96 percent of the GDP, while 1 percent growth is inadequate to defuse the challenge. What's worse, while Brussels may have political will to contain the debt burden, it lacks the institutions to do so.
Second, in advanced economies, general government debt is a result of a long-term gap between revenues and expenditures. The leverage is structural. In China, government debt is still tolerable, whereas excessive leverage evolved largely at the local level following the 2009 stimulus.
Nevertheless, China's credit expansion remains about 13 percent; twice as high as the country's growth pace. Moreover, concern is increasing about shadow banking-associated indebtedness.
Balancing accommodation and reforms
In May, some authoritative policymakers stated that excessive leverage would have dire consequences over time. They advocate reforms sooner rather than later.
In practice, the timing and phasing of reforms has been complicated by the most challenging international environment since the 1930s. Recently, the International Monetary Fund (IMF), once again, cut global growth forecast to 3.4 percent, due to the Brexit-induced increase in economic, political and institutional uncertainty.
Earlier this week, President Xi said that economic policies should be accommodative to ensure growth will stay on track. He also emphasized the need to push ahead with supply-side reforms as the Politburo discussed economic policies for the second half of the year.
In its statement, the Politburo noted that the key to retiring redundant capacity and deleveraging involved deepening reforms of state-owned enterprises and financial institutions and reducing oversupply in the property sector.
Understandably, none of these reforms can happen overnight. But many of them must occur in the medium-term. The second half of the year will provide a better idea of the policymakers' preferred balancing act between policy accommodation and reform timetable. And that, in turn, will determine the pace of growth deceleration in the coming years.
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