The International Monetary Fund’s latest World Economic Outlook notes how growth in the leading developing economies, including China, has slowed more than expected. The IMF is now forecasting 7.6% growth this year for China and 7.3% next year, down 0.2 percentage points and 0.4 percentage points respectively from the forecast it made in July. The question is whether this slowdown is cyclical or structural. In China’s case, the Fund says, it is the latter with a cyclical component on top as China comes off a cyclical peak.
What to to about it? First, the Fund says, policymakers have to adjust to lower potential growth, which makes structural reforms to ease the adjustment more urgent. That means rebalancing away from exports and investment toward consumption becomes a priority. “Time is running out on [China’s] current growth model,” the Fund says (though we all sort of know that by now).
As President Xi Jinping has recently signaled, China will grow more slowly over the medium term than in the recent past. No longer can it be taken as a given that stimulus will be the boilerplate policy response to growth falling towards 7.5% — even if it is an instinct that will not be easily kept at bay. That, in turn. will affect may other economies, particularly commodity exporters.
Evidence of this new approach can be seen in the way Beijing is attempting to rein in the flow of credit, including through shadow banks, and opting for targeted support, such as to small businesses, over widespread stimulus. The stimulative expansion of credit in the immediate aftermath of the 2008 global crisis contributed to an investment boom that created massive excess capacity, with capital accumulation running well ahead of domestic demand.
By 2012 investment reached close to 50% of GDP and credit reached almost 200 percent. Deteriorating asset quality, the rat hole of local government’s off-balance sheet spending, and the risk of financial instability are the costs. More balanced growth, the IMF notes, reduces the risk of a hard landing — an event that it has previously estimated could knock 1.5% off global GDP.
A smooth shift to more sustainable, private-consumption-based growth would require, the Fund says,
- liberalizing interest rates to allow effective pricing of risk;
- a more transparent, interest-rate-based monetary policy framework;
- a more flexible exchange rate regime;
- reforms for better governance and quality of growth;
- and strengthened financial sector regulation and supervision.
There is nothing novel in that list. The headings could come straight out of Beijing’s current five-year plan, or the World Bank’s playbook, come to that. In short, fiscal and financial reforms are necessary to reduce both public and private saving to free up cash for private consumption, while deregulation of markets and services is need to stimulate productivity growth as the flow of surplus labour from farm to factory exhausts itself. The question is how quickly the leadership can push through the reforms, and how evenly across the board given the varying points of resistance among vested interests that will be disadvantaged by them (more anti-corruption campaigning may be in order to clear the way).
Unlike some of the other large emerging economies, China’s fiscal position is strong enough to absorb reform, though the window is closing. The government can both maintain social and priority spending and address downside contingencies, even if, as the IMF recommends, it should curtail quasifiscal programs, a reference, we suspect, to the temptation to the recapitalization of illiquid and insolvent financial institutions and state-owned enterprises by non-monetary means.
That only leaves Xi with the task of convincing the country’s population, and especially the restive, younger part raised on double-digit growth, that slower growth at the right sustainable pace will actually leave them better off in the long run — something, not uncoincidentally, that would leave the Party better off, too.