The Curious Incident Of The Growth Forecast That Didn’t Change

Inspector Gregory of Scotland Yard: “Is there any other point to which you would wish to draw my attention?”
Sherlock Holmes: “To the curious incident of the dog in the night-time.”
Gregory: “The dog did nothing in the night-time.”
Holmes: “That was the curious incident.”

THE INTERNATIONAL MONETARY Fund’s newly published World Economic Outlook forecasts China’s growth this year and next at 6.8% and 6.3% respectively. Those are exactly the same numbers it published in its July and April revisions to its 2015 Outlook.

Since April, the Fund has cut its forecasts for the global economy to 3.1% from 3.5% for this year and to 3.6% from 3.8% for 2016. China’s stock market has slumped precipitously. The economy’s appetite for commodities, particularly base metals, has diminished, further depressing global commodities prices. The People’s Bank of China has devalued the yuan and been spending down the country’s foreign-exchange reserves to defend the currency. The U.S. Federal Reserve has been sufficiently concerned about the combined effect on the U.S. economy of all those factors to delay raising its policy interest rates. Investors have begun to fret that a gradual slowing of China’s growth may turn into a hard landing.

Yet the IMF’s forecasts for China have remained serene. Either its forecasters are prescient to a point their track record scarcely justifies or they are being, let us say, judicious in their judgement. They do have some previous in that last regard, albeit that is not unique to China.

The Outlook’s summary description of developments in the economy:

Investment growth slowed compared with last year and imports contracted, but consumption growth remained steady. While exports were also weaker than expected, they declined less than imports, and net exports contributed positively to growth. Equity prices have dropped sharply since July after a one-year bull run. While the authorities intervened to restore orderly market conditions, market volatility remained elevated through August.

And the rationale for the forecasts.

Growth in China is expected to decline to 6.8 percent this year and 6.3 percent in 2016—unchanged projections relative to April. Previous excesses in real estate, credit, and investment continue to unwind, with a further moderation in the growth rates of investment, especially that in residential real estate. The forecast assumes that policy action will be consistent with reducing vulnerabilities from recent rapid credit and investment growth and hence not aim at fully offsetting the underlying moderation in activity. Ongoing implementation of structural reforms and lower oil and other commodity prices are expected to expand consumer-oriented activities, partly buffering the slowdown. The decline in stock market valuations is assumed to have only a modest effect on consumption (reflecting modest household holdings), and the current episode of financial market volatility is assumed to unwind without sizable macroeconomic disruptions.

Burying down in to the report reveals downside risks, notably if “the macroeconomic management of the end of the investment and credit boom of 2009–12 proves more challenging than expected”, i.e., if the debt bomb goes off with more of a bang than a whimper.

The Fund thinks that if any further slowing of growth is moderate, policymakers will pay more attention to defusing the credit risk than on supporting growth. However, if there is the threat of a hard landing then old-school pump-priming will be undertaken to shore up growth, even though that heightens the debt risk in the longer term.

The Fund’s prescription for the future also remains unchanged.

Policymakers in China face the challenge of simultaneously achieving three objectives: avoiding a sharp growth slowdown in the transition to more sustainable patterns of growth, reducing vulnerabilities from excess leverage after a credit and investment boom, and strengthening the role of market forces in the economy. Modest further policy support to ensure that growth does not fall sharply is likely to be needed, but further progress in implementing the authorities’ structural reforms will be critical for private consumption to pick up some of the slack from slowing investment growth. The core of the reforms is to give market mechanisms a more decisive role in the economy, eliminate distortions, and strengthen institutions. Examples include financial sector reforms to strengthen regulation and supervision, liberalize deposit rates, increase the reliance on interest rates as an instrument of monetary policy, and eliminate widespread implicit guarantees; fiscal and social security reforms; and reforms of state-owned enterprises, including leveling the playing field between the public and private sectors. The recent change in China’s exchange rate system provides the basis for a more market-determined exchange rate, but much depends on implementation. A floating exchange rate will enhance monetary policy autonomy and help the economy adjust to external shocks, as China continues to become more integrated into both the global economy and global financial markets.


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