Editorial: Relax Rigid Growth Target to Create Room for Reforms
The year 2017 will be a mixed bag for China’s economy, with several causes for optimism along with risks, and the progress of reforms will be the key determinant of its growth. Therefore, policymakers must drop rigid growth targets and adopt more flexible ones, which leave maneuvering room for a fundamental shake-up of China’s economy.
The global economy has suffered several blows in the past year, including Britain’s decision to leave the European Union, continued unrest in the Middle East that is threatening to spill over to other parts of the world, and the election of Donald Trump as president of the U.S., all of which threaten to undermine the process of globalization and integration. The world economy is still hobbling on at a feeble pace, and its weak recovery has shed light on some long-term structural problems.
China’s economy is also held back by structural problems that have been worsened by the old growth model. One of the major risks is a looming debt bubble that threatens local governments and state-backed enterprises and other default risks from the loosely regulated fintech sector. Policies to prevent these financial risks from spilling out and poisoning the entire system are a much more urgent priority than fiscal measures designed to stabilize growth in the new year.
Chinese policymakers have long been in the habit of pursuing rigid short-term and long-term growth targets. But this approach is flawed. As the country’s economy enters a period of relatively slower but sustainable growth, dubbed by bureaucrats as the “new normal,” sustaining the pace of growth seen in previous years becomes even more challenging. However, some officials are pushing to maintain high growth rates at whatever cost, worsening overcapacity in industries such as coal and steel and adding to the mountains of local government debt. Such practices are a legacy from a time when China was a planned economy and thwarted market forces. Few countries in the world still set annual growth targets. Instead, many are observing indexes such as inflation and unemployment to measure the health of an economy, and using these indicators as references when setting policies.
In recent years, the Chinese government has gradually moved away from setting binding growth targets, choosing to issue projections instead. In 2016, for the first time ever, Beijing gave itself more wiggle room by setting a growth range between 6.5% and 7%. At the Central Economic Work Conference in December, which sets the tone for development policies in 2017, top leaders stuck to the oft-repeated goal of “seeking progress, while maintaining stability.” But they stopped short of adding the phrase “sustaining economic operations within a proper range,” as they did in the previous year, signaling a change in attitudes.
This change comes as policymakers are less worried about a hard landing after the economy has shown signs of stabilizing. But trouble is brewing in the country’s loosely regulated financial sector. Pursuing faster growth without trimming local debt and reining in soaring property prices could deal a heavy blow to the Chinese economy.
The Central Economic Work Conference last year focused on mitigating such risks. We believe the major fault lines that can disrupt the country’s growth trajectory are as follows:
The real economy, especially the manufacturing sector that has suffered from a prolonged downturn, is battered by a rising leverage ratio and souring assets. Previous policy tools introduced to trim local government debt, including special investment funds and public-private partnership projects, have been misused to raise further loans. Meanwhile, surging housing prices in large and midsize cities have pushed up business costs.
In the financial sector, highly leveraged derivatives, which are disguised as innovative financial products, have flooded the market partly due to the lack of adequate supervision. Some of the investment products that promise investors high returns within a short period actually rely on projects with a long gestation period for payback. Their operations resemble Ponzi schemes, in which money from a fresh batch of investors is used to pay back a previous group. Such practices can easily lead to a liquidity crunch and have a domino effect, destabilizing the entire financial system.
Moreover, the U.S. Federal Reserve's recent interest rate hike and suggestions of more-than-expected increases in future have fueled speculations of a weaker yuan that may lead to further capital flight.
China’s economy, which has grown at a breakneck speed in the past two decades, has also led to certain imbalances. First, there is a supply glut in coal, cement and steel due to overcapacity, while other sectors have seen slower growth. Next, a significant amount of money has been sucked out of the real economy and channeled into financial markets or shadow banks. Finally, speculative buying raised real estate prices to record highs last year.
Risks threatening to derail the Chinese economy are closely linked to these imbalances, which can only be mitigated by deepening reforms. The country can only unleash its economic potential and restore investor confidence by rectifying these imbalances.
Three years after the ruling Communist Party put the final touches on a blueprint for economic reform at a key party meeting, progress has fallen short of expectations in some key areas, such as changes to state-owned enterprises (SOEs), fiscal and taxation systems, land management and social welfare. This has slowed down attempts at an overall structural shake-up. This is partly because reforms have always taken a back seat to short-term growth. The central government has made SOE reforms a top priority in 2017 and highlighted the need for mixed ownership of giants in sectors like electricity, oil, gas, railways, civil aviation and telecommunications. While this is a step in the right direction, the market needs to see concrete progress to gauge China’s actual commitment to reform.
Emerging economic fault lines should not hinder reform efforts. The country must also remain steadfast on its course towards further opening-up and liberalization despite changes on the world stage. There are both opportunities and risks ahead for China in 2017, and all levels of governments should focus on identifying and mitigating these risks. There is no shortcut for this other than to deepen reforms.
Hu Shuli is the chief editor of Caixin Media.
Founder & Publisher, Caixin Media
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