Getting back to growth

The coronavirus is shaking up decades of certainties in the Chinese economy. GDP shrank for the first time in decades in the first three months of this year and now the government is dropping its growth targets completely for 2020, because of the pandemic.

The decision was anticipated by analysts ahead of the rearranged meeting of the National People’s Congress, where Li Keqiang, China’s premier, delivered his annual address on the economy at the end of last week.

“We have not set a specific target for economic growth this year,” he told delegates in the Great Hall of the People. “This is because our country will face some factors that are difficult to predict in its development due to the great uncertainty regarding the Covid-19 pandemic and the world economic and trade environment.”

Setting a target was not realistic in the circumstances, Xi Jinping, China’s leader, reportedly told delegates in a closed session. “Our focus cannot be on GDP growth.”

Critics of the targets have long argued that they prioritise ‘quantity over quality’ in the economy and that government officials chase them blindly, to the detriment of their other responsibilities. All the same, dropping them completely is a significant moment – the first time in more than a quarter of a century that Beijing has decided against setting goals for growth.

It also points to how drastically the economy has been slowing: HSBC’s forecast is for 1.7% growth for the full year, a huge drop on 6.1% in 2019.

An economy performing at these levels is going to mean another setback for Xi’s government by making it impossible to fulfill his aim to double per capita income over the last decade – an achievement that had been timed to coincide with the centenary next year of the founding of the Chinese Communist Party.

For the meantime the focus is on keeping small and medium-sized enterprises (SMEs) afloat, in recognition of their crucial role as China’s main job creators.

Li Keqiang announced a target of nine million new urban jobs in the coming year, which is actually the lowest in seven years and down from last year’s goal of 11 million. Urban unemployment rates have risen to about 5.5%, although most commentators believe that the official figures are substantially understated.

“We will make every effort to stabilise and expand employment,” Li said. “We will strive to keep existing jobs secure, work actively to create new ones and help unemployed people find work.”

That effort includes a promise that money and credit growth will be “significantly higher” than last year, with more cuts to bank reserve ratios to free up cash for loans (and more pressure put on banks to lend to smaller firms), as well another round of reductions in interest rates.

SMEs will get another helping hand through tax cuts and drops in social security contributions, and there will be rental holidays in cases where they have state-owned landlords.

The goal here is to keep companies going long enough to give them a chance of reaching the hoped-for recovery later in the year.

Policymakers are also falling back on a tried-and-tested technique for stimulating demand in the domestic economy by channelling billions of yuan into infrastructure projects. Campaigns like these are increasingly contentious, with critics taking the view that China is moving past the point at which massive spending on roads, railways and bridges delivers the same boost to the economy that it did in the past. HSBC’s economics team disagrees, saying that targeted investment still brings meaningful returns, especially in ‘new’ areas like 5G networks and charging stations for electric vehicles, which were both mentioned in Li’s speech.

In the latest plan much of the infrastructure investment will go into another round of spending on high-speed railways and intercity train lines as well.

There’s also the question of how all of this is going to be paid for. Some of the burden is going to fall on government-backed asset managers, which will be required to transfer a share of their financial resources. In addition there will be another round of debt financing from local governments, who will sell Rmb3.75 trillion ($525 billion) in special bonds, and from the central government, which will issue a further Rmb1 trillion of ‘anti-virus’ bonds itself.

Special bonds like these generally aren’t included in the government’s calculations on the fiscal deficit because they are seen as one-off measures. That allows Li to limit the widening of this year’s forecasted budget deficit to 3.6% of gross domestic product, which is beyond the 3% threshold seen as an unofficial red line in the past. However, the deficit broadens out to more than 8% if the special bonds are included.

The state media has been keen to point out that the circumstances are exceptional and that other governments are increasing their budget deficits substantially more than China. There’s been consistent coverage of IMF data showing that China’s deficit-to-GDP ratio isn’t high compared with other countries as well. The global average is expected to jump to 9.9% in 2020 from 3.7% in 2019, with the mean in developed economies growing to 10.7%.

In fact, the fiscal package being proposed is less expansive than many analysts were predicting. Yes, its supports spending levels that surpasses the stimulus campaign after the 2008 global financial crisis. But China’s economy today is about three times bigger than back then, so the impact is going to be less striking.

China’s leaders haven’t committed more resources to the stimulus because they want to avoid speculative run-ups in asset prices and unsustainable debt increases that could have long-lasting implications. One of the bigger concerns about setting a hard target for GDP was that people would be “too preoccupied with overly stimulating the economy”, Xi explained, before calling for a focus “on our overall development objectives”.

The message is that Xi wants to maintain fiscal discipline as far as he can, despite uncertainty about how well the global economy is going to shrug off the deadweight of the pandemic. Yet Li and his team have also been careful to describe the deficit as being 3.6% ‘or more’ for the remainder of the year, leaving room for further intervention if the gloom shows no sign of lifting.

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