20 February 2019
China's central bank has not shifted to a devaluation policy and the renminbi is still under appreciation pressure in the medium term. Photo: Bloomberg
China's central bank has not shifted to a devaluation policy and the renminbi is still under appreciation pressure in the medium term. Photo: Bloomberg

China growth slowdown engineered by choice

China’s economic slowdown is mostly a sign of Beijing’s attempts to fix the country’s economic woes rather than the result of economic woes, as many have wrongly assumed.

It is a planned slowdown to refocus the policy on growth from quantity to quality. Devaluing the renminbi will not help this structural transition process, as some have wrongly argued. The People’s Bank of China has not shifted to a devaluation policy and the Chinese currency is still under appreciation pressure in the medium term, albeit with relatively higher volatility than in the past.

China’s growth momentum has slowed more sharply than Beijing had expected, highlighting the short-term risk of structural changes. However, the combination of a closed capital account, ample financial resources and a banking system still under state control argues that Beijing could still boost growth if it wants to. So far it has chosen to tolerate slower growth as a strategy to balance economic growth with structural reform.

Granted, no “big bang” structural reforms have been implemented yet, as Beijing needs to manage the interests of winners and losers in the reform process. But it has been paving the way for “economic surgery” since 2013, noticeably by tolerating slower growth and pursuing cautious monetary and fiscal policies.

This balancing act has already reduced excess liquidity, forced the economy to deleverage, cut excessive investment and government spending, and hit corruption. It has also taken small steps to liberalize interest rates, open up previously protected sectors to private investment, and expand investment quotas for foreign participation in the onshore capital market, thus introducing some degree of market discipline to the domestic system.

Nevertheless, the sharp deceleration in growth suggests that Beijing might have underestimated the economic pains of structural change. To strike a balance between reform and growth, it has come up with a “mini” economic stimulus package, using tax, lending and spending policies to boost targeted sectors, including small and medium-sized companies, social housing, energy, urban infrastructure, and central and western regional infrastructure.

It has also implemented a “discriminatory” credit easing policy by cutting bank reserve requirement ratios (RRR) for qualified rural banks only. Arguably, this is a “surgical” move to boost credit and, thus, growth in the rural areas. However, it is doubtful whether the expected benefits of the “discriminatory” RRR cut will materialize because rural banks have an average excess RRR of over 7 percent, compared to 2.3 percent for all other banks – a lower RRR may not necessarily prompt the rural banks to increase lending.

If the growth impact is uncertain, then why does Beijing still want to implement this “mini” stimulus package, including the “discriminatory” RRR cut? The likely answer, in my view, is Beijing’s desire to send a subtle signal about its resolve to reform.

China’s economy is suffering from “growth fatigue”. Beijing knows that another wholesale bailout package would boost growth but less effectively than before due to the distortions that have been built up in the system.

But reverting to the old bailout model will both undermine the reform resolve and hurt policy credibility. The “mini” stimulus package is aimed at striking a growth-reform balance by boosting selective sectors that need genuine investment without spurring excessive investment.

The sharper than expected slowdown in growth on the back of falling liquidity is not, as many have assumed, exclusively the result of China’s economic woes. It is also proof of Beijing’s reform resolve at the expense of growth to fix the economic woes.

If the “mini” stimulus package is insufficient to arrest the slowdown in growth, Beijing is expected to increase the stimulus further, perhaps even in the form of interest rate and RRR cuts.

Current liquidity seems to be tight relative to profit conditions. The weighted average for the one-year lending rate is about 7.4 percent, but the average corporate profit margin is about 5 percent. Further, broad money supply (M2) growth and net aggregate financing have both fallen sharply due to a (perhaps overly) cautious monetary policy stance. Ongoing deleveraging will also keep overall credit conditions tight.

If growth momentum remains sluggish in the coming months, further policy easing is likely. However, the very low odds for a hard landing suggests that further policy easing might be just the recipe for a rebound in Chinese asset prices that the market is looking for. If growth momentum returns and inflation remains subdued, China’s outlook will improve.

What is clear is that China is not in a crisis. The economic slowdown is more a sign of Beijing trying to fix economic woes than a result of economic woes. It is an economic slowdown engineered by choice, and for good reasons.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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