Has Premier Li Keqiang just unleashed a weapon of mass construction? That was the question on the minds of analysts last week after the State Council announced another investment programme designed to boost China’s slowing growth. Will the plan work? Or should the news dishearten reformers who say that China’s economy must shift to a more sustainable model and avoid a return to stimulus spending?
What was announced?
The main items were tax breaks for small businesses, more investment in railways and a further focus on redeveloping some of the country’s poorest shantytowns.
Under the extension of an existing policy – due to be dropped at the end of next year – small businesses will now hold on to their tax cuts until the end of 2016. The State Council also seems to be saying that thresholds for the tax cut might be raised too.
The renewed focus on low-income housing was more in keeping with Premier Li’s visit late last month to deprived areas of Chifeng, a large city in Inner Mongolia. There, Li publicised efforts to build 4.7 million apartments in urban slums, telling residents: “We can’t let our people live in shanty houses while building skyscrapers on the other side of the road.” The media has reported that Rmb1 trillion ($162 billion) will be invested in construction efforts this year.
The third promise was to accelerate railway construction. Another 6,600km of line is to be started this year, an increase of 1,000km on last year, much of it in inland provinces.
Why is the spending seen as significant?
In the short term, it looks like a response to anxiety in Beijing about meeting growth goals. Li Keqiang talked at the National People’s Congress last month about having some flexibility around achieving this year’s 7.5% GDP target (see WiC230), preferring to focus on a combination of job creation, price stability, as well as growth figures as a better measure for economic performance. But the numbers for the first quarter look like they might test the limits of the new thinking. Growth is going to be down on the last three months of last year, say Qu Hongbin and Sun Junwei at HSBC, and in coming months might even slide below 7% (on a year-on-year basis) based on the current outlook.
That would be unacceptable to the State Council, especially as Li has indicated that 7.2% is the minimum threshold for generating China’s required 10 million new jobs a year.
So the measures announced this month are intended to stabilise the economic mood. But they also lead to questions about the broader effort to restructure the economy – an initiative sometimes referred to as Likonomics (for more on Li’s economic thinking, see WiC186).
The Likonomics blueprint comprises three main parts – no new stimulus, as well as deleveraging and pushing through structural reforms – the South China Morning Post noted this week. But Li now seems to be backing away from his aversion to pump-priming the economy, and to be returning to the more traditional box of policy tricks. Does that mean that we should forget about Likonomics as a reforming agenda and that economic policy is all about stimulus once again?
This time it’s different…
This is what the policymakers are saying. For a start, the proposed investment is relatively limited in size. Analysts haven’t come up with a number for the total being promised, saying that there isn’t enough information to support a calculation. But what’s clear is that it won’t come close to the Rmb4 trillion (equivalent to $586 billion at the time) used to counter the global financial crisis in 2008.
The measures are being termed as more of a “mini-stimulus”, even if government ministers seem reluctant to say so openly. “They are doing it quietly. They cannot use the word stimulus, which has become a negative word,” Xu Gao, chief economist at Everbright Securities, told Reuters.
But Xinhua couldn’t avoid the term entirely, arguing that this year’s plan is very different to earlier ones. “China has quit the habit of resorting to the so-called ‘masterpiece’ stimulus, which could be as addictive and damaging for a national economy as doping is for the human body,” the state news agency explained this week. “China’s economy needs a little stimulation but not a fully fledged stimulus. The tax breaks and acceleration of railway investment will certainly inject new blood into the faltering economy, but they do not forebode any massive spending or borrowing.”
Others chose to highlight the differences in how the money is being spent. China must avoid a repeat of the worst excesses of the Rmb4 trillion campaign, warned ifeng.com, which was hijacked by local governments and state-owned firms. The stimulus binge also bred overcapacity in industries like steel, real estate and cement, and opened up colossal new opportunities for graft. But this time around, the measures are targeted at areas of the economy more likely to deliver a return on investment.
That’s especially so in the focus on railways, where HSBC has long argued that China is significantly underinvested. One of its favourite datapoints: that the rail network at the end of 2012 (at 98,000km) was about the same length as that of the United States in the 1890s. The system carries 24% of global freight volumes on just 6% of world capacity, HSBC has also argued, and 100 cities with populations of more than 5 million people still don’t have subway transport.
Beijing News says that more diverse sources of capital are being drawn into the investment process too, another major difference to 2008. China Development Bank will issue a special bond for shantytown redevelopment, for instance, and will raise capital from financial institutions including the Postal Savings Bank of China, commercial banks, social security funds and insurers. Private sector funding will also be sourced for the railways, partly through a special fund worth up to Rmb300 billion, as well as through the issuance of Rmb150 billion of bonds to finance the build-out.
By contrast, much of the 2008 stimulus was funded with bank loans. This is now seen as a mistake, not only because much of the lending was poorly conceived or wasteful, but also because the payback periods for the better projects have turned out to be longer than most of the loans themselves. The new plans look different, helping to shift the financial burden away from the banks and local governments to a broader range of investors.
Will the mini-stimulus work?
Underwhelmed is probably the best word to describe the initial reaction to the plan (much less intervention from the central government than anticipated, the Shanghai Securities News thought) and Chinese stock markets fell. Since then, the bourses have done better and the key Shanghai Composite has rallied to a six-week high on speculation that more measures may be announced.
One reason for the lukewarm response to last week’s announcement is that it contained little that is genuinely new. Most of the policy steps didn’t sound very different to proposals from last July, when the State Council made a similar set of announcements (see WiC204). For instance, Rafael Halpin, a China analyst for the Financial Times, told the Beyondbrics blog that the 6,600km of new railway track was a pre-existing target and shouldn’t count as fresh investment. Nor is an uptick in affordable housing construction going to be much help, Halpin believes, as it will be overshadowed by the slowdown in the private housing market. Social housing accounted for 13% of total investment in urban homes last year, so an increase in spending doesn’t look likely to offset wider weakness in the sector.
Investment levels in much of the economy are slowing, especially in manfacturing. This week the official government measure recorded a slight pick-up in manufacturing activity for March (although economists say this is typical after Lunar New Year holidays in February).
But HSBC’s PMI scores fell to an eight-month low, indicating that the sector is continuing to contract.
Investment in real estate has held up better but it could come under pressure after weeks of slower housing sales (new construction fell by more than a quarter in terms of floor space in January and February too). Elsewhere the anti-extravagance campaign is biting into retail sales, while consumers are the least confident about their future incomes than at any time since 2001, according to household surveys from the People’s Bank of China.
With people preferring to save rather than to spend more, private consumption isn’t going to provide much of a growth fillip. Hence the view that more capital might be pumped through the investment pipeline in coming months.
“This may be the start of a slew of fine-tuning measures,” HSBC concludes. “We think Beijing still has other options in their toolkit, such as the lowering of the entry barriers in various sectors, spending or incentives for environmental protection, as well as more urban infrastructure (such as subways), if needed.”
Might that include monetary loosening as well? Despite assurances to the contrary from Xinhua – “The smart ones have got it. There is no sign of a monetary and fiscal policy shift” – Beijing could reassess its options if the economy shows further signs of frailty.
One possibility would be to reduce reserve requirements at the banks, freeing up more capital for lending. Granting more credit is the best way to goose up growth, according to the FT’s Halpin, which is why the investment binge in 2008 was supported by a huge surge in new lending. Even last year’s uptick in spending was accompanied by an increase of about a third in social financing in the preceding six months. But the same credit conditions don’t apply today, Halpin says. Social financing is down 3% in the first two months of the year on the same period in 2013. The People’s Bank of China (PBoC) has also been draining liquidity from the interbank market in recent weeks, suggesting its focus remains on containing excessive credit.
Can China refashion its economy and meet growth targets at the same time?
This is the question at the heart of the economic debate, especially with signs that some of the policies initiated by Xi Jinping and Li Keqiang are starting to work, albeit with economic side effects.
One exhibit is the attack on wasteful spending among public sector officials. It is delivering savings for the public purse, but it also seems to be curtailing retail sales, which increased by a multi-year low of 11.8% in the first two months of the year.
Another is the drop in manufacturing investment, which includes reductions of capacity in bloated industries like steel and cement. This is another very deliberate policy from Xi Jinping’s leadership team designed to root out inefficiency and oversupply. HSBC reports that investment in steel production grew by just 0.7% last year (or 3.7% less than the year before), while another 270 million tonnes of capacity is scheduled for elimination this year.
Despite this, HSBC disapproves of the notion that efforts to remodel the economy must necessarily hurt growth, even in the short term. Instead it believes that the “modest” stimulus this month is important in buying time for further reforms to take hold. The view is that a proper sequencing of policy changes will add up to reform dividends that then spur the economy forward.
But the countervailing question is whether China’s leaders will be able to maintain growth at levels they have stipulated as they rein in credit, confront weaker global demand, fight corruption and push for the largest overhaul of the country’s economic model in more than a generation.
This isn’t just about the complexity of following such a challenging path. Michael Pettis, a finance professor at Guanghua School of Management at Peking University, says there is a much starker choice ahead if China pushes forward with its economic reboot – and that there has to be a period of purgatory before profit.
“Low interest rates, low wages, an undervalued currency, nearly unlimited access to credit for state-owned enterprises, a relaxed attitude to environmental degradation, and other related conditions were both the source of China’s ferocious growth as well as of China’s unprecedented economic imbalances,” Pettis warned earlier this year. “Reversing these conditions will rebalance the economy, but will do so while lowering growth in the obverse way that these conditions had accelerated growth.”
Of course, this runs counter to the view that reform is going to have a rapid booster effect. In fact, Pettis is claiming the opposite: that if the restructuring effort proceeds at a proper pace we will start to see growth drop, probably quite sharply (he thinks growth rates will fall to an annual average of 3% before the end of the decade).
For those who buy into this bearish outlook, a Goldilocks outcome isn’t on the agenda.
However, in his most recent remarks – made at the Boao Forum on Thursday – Li again indicated he wouldn’t be panicked into pulling a giant stimulus lever (even as export numbers came in well below expectations for March). “We will not resort to short-term stimulus policies just because of temporary economic fluctuations and we will pay more attention to sound development in the medium to long run,” Li declared.
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