China Continues to Focus on Growth, Not Reform

By Alicia García-Herrero, the Chief Economist for the Asia Pacific at NATIXIS and an adjunct professor at City University of Hong Kong and Hong Kong University of Science and Technology (HKUST) and visiting faculty at China-Europe International Business School (CEIBS). Originally published at Bruegel

The central government will hold the National People’s Congress (NPC) meeting on March 5th. All the signs point to more monetary and fiscal stimulus, especially since the G20 gathering in Shanghai. The key is how to use the fiscal stimulus efficiently.

Given the traumatic experience with the large fiscal stimulus in 2008-09, the NPC will need to be cautious about the announcement and the implementation of any stimulus.

The key concern for those against additional stimulus in China is that it will only feed overcapacity in state-owned enterprises. This is why I expect a strong warning in the NPC statement that the stimulus will exclude “zombie companies”, loss-making state-owned firms that use up lots of resources.

The Elephant in the NPC Meeting Room: Excess Capacity

After a series of official spokesmen confirmed that the central government is determined to tackle overcapacity, it is clear that the NPC will need to make reference to this issue.

It may even announce concrete measures, such as restructuring of zombie companies in sectors which have more capacity than is needed, including steel, cement, coal, flat panel glass, paper making and shipbuilding.

There are rumours that funds of at least 150 billion yuan, equivalent to $23 billion, will be earmarked to help corporates lay off 5 to 6 million workers and retrain them within 3 years.

Given the amount of excess capacity in China, and the fact that fiscal and monetary policy will be more lax than they are even now, it is difficult to believe that the above strategy will solve the problem. The incentives to accumulate additional overcapacity will still be there.

This is why the search for external demand is still very important for China’s leadership. This – beyond more political and strategic considerations – explains Xi Jinping’s strong push for the Belt and Road mega-initiative. We, thus expect the NPC to announce a series of policies to facilitate investment projects along the Belt and Road, thereby, dumping excess capacity on neighbouring economies.

Domestically, one more way to reduce excess capacity would be a boost in urbanisation. During the October Party Plenum it was announced that some 100 million Chinese people would be urbanised in the next five years, and we expect this to be repeated or even strengthened. It goes without saying that such a process will increase demand for urban infrastructure, which relates to the sectors with excess capacity.

In the same vein, there is a push to use fiscal means to subsidize house buying plans, which, together with faster urbanisation, should help support China’s housing market, particularly in the second tier cities.

It seems that the leadership’s fear that China’s housing market may have become too large for the size of the economy has abated, and that maintaining high growth has become the one and only target.

Fiscal Expansion

The People’s Bank of China (PBoC) has estimated that fiscal spending could go up to RMB 2.9 trillion this year (from RMB 1.6 trillion in 2015), an increase of over 80%, equivalent to 4% of 2016 GDP.

Based on the PBoC’s own assumptions, such fiscal policy could continue for the next 10 years, which would raise debt from 53% in 2015 to 70% in 2025 (based again on PBoC’s own numbers). The Chinese government probably feels they have room to do this, as such a debt level is low compared to the developed world, where there are levels of over 90% of government debt to GDP.

Monetary Expansion

The PBoC is back and ready to do its upmost to support economic growth. Aware that such massive open market operations as those conducted since late January cannot be maintained to inject liquidity, the PBoC cut banks’ reserve requirement rate (RRR) last Monday. This opens the door to more lax monetary policy in a more structural way.

In this context, the market rumour that a 2016 consumer price index (CPI) target of 3% will be announced at the NPC meeting hints at a much more lax monetary policy in the future, under the mantra that the PBoC is pre-emptively reducing deflationary pressures.

We expect at least two more RRR cuts this year. On top of that, the NPC may also announce a very lax M2 money supply growth target for 2016 (13%), even when compared with their nominal growth target (9.5% if the rumours of a 3% inflation target are confirmed).

As if this were not enough, the government is keen to receive liquidity from the rest of the world and to go back to net capital inflows instead of outflows. This has been behind the reduction of the PBoC’s balance sheet, notwithstanding the PBoC’s liquidity injections and, thereby, the expansion of net domestic assets in the PBoC’s balance sheet.

Many of the announcements to attract capital inflows have already happened. However it is likely that the NPC will dwell on them further, so that the opening of China’s bond and money market to foreign investors is perceived as a landmark in China’s opening up of the capital account.

All in all, China’s leadership does not yet seem ready to change the course of action at their national gathering this weekend. It looks as if muddling through is going to be the preferred option as opposed to stepping up reform.

The key signal is that the growth target has not been lowered and that monetary and fiscal expansions have already been announced. The elephant in the room, the reform of state-owned enterprises to reduce excess capacity, will not be tackled fully.

But this is an increasing point of contention for investors, and the communiqué of the NPC meeting will have to mention dealing with zombie companies, as well as the availability of funds to restructure some of those corporations. This is welcome but it is clearly not enough. Therefore I, expect China to continue to focus on growth and not on reform overall.

Print Friendly, PDF & Email


  1. TomDority

    I may be totally wrong but, the perspective is always from the point of view of the investor. For example; ‘the housing market is too big for the economy’….. my question would be: Is the housing market big enough for the planned urbanization? or, Is the housing price too high for the economy to generate internal demand for other sectors of the economy. Here in the USA we still have millions of homeless and millions of empty homes……seems to me a problem exists but, …..the economy.

    1. Steve H.

      China has millions of empty properties also. They were invested in by nouveau unpoverished looking for some thing to act as a store of wealth.

      Two differences there weigh large (I may be corrected on these). My impression is that those building projects were to spread state wealth to the builders, as often happens here but on a grander scale for residences. I have not heard of orders-of-magnitude derivatives piled on top as they are in the U.S.

      The U.S. also does not have a method of forced migration. Those empty cities could be filled very quickly by state mandate. The properties then become revenue generating.

      Contrast that to this comment:

      1. susan the other

        yes. that Nathan Tankus interview was an eye opener, the way real-estate-appreciation-for-capital-gains-only works in NYC. The Chinese are probably on the right track if their goal is still to increase domestic consumption and rely less on trade. They could fiat a housing authority by rolling up all their other SOEs into it and use it to subsidize a progrm giving every person a house/apartment making them all instantly homeowner/consumers. Two birds, one stone. Not too sure about offsetting their capital flight with foreign-friendly Chinese bonds – but maybe it’s genius.

      2. Yves Smith Post author

        The housing is what amounts to middle-upper middle class housing. It’s most decidedly not what you’d build to house migrants from the countryside working in factories. It’s mal-investment on a grand scale.

        And do you think, even assuming there are enough middle class people, say in 30 years to fill this housing , that they are going to want to live in properties that are that dated? These would all need to be redone to appeal to the then-current market.

        1. Steve H.

          Exactly, they’re worthless that far in the future. With about a fifth of units bought but empty, the drop in demand is a problem for developers. The government is willing to step in to help address the problem. In Chicago, they moved whole neighborhoods against the residents wishes. China has history of doing the same on a city-level scale. Communes could be 200,000 people.

          This article gives a bit more detail on how they’re trying to keep the ball rolling:

          A strength I think China has, as far as I know, is they don’t have bets laden on top of the properties, so they can be freer than the U.S. in allowing devaluation. If they have avoided that, they can practice a different form of central planning than practiced by U.S. financial interests.

        2. MyWag

          Regardless of Chinese mistakes, do they seem to be trying to adapt to MMT provisions?
          So far they haven’t, as the US has:
          * exported vast segments of their economy to foreign competitors

          The US, being profit driven and not nationalistic; has exported huge segments of it’s economy overseas.

      3. PlutoniumKun

        When Chinese people talk about property, they talk about prices ‘per metre square’. Most of those homes are bought as stores of value. Surprisingly few rent them out for reasons I’ve never fully understood.

        The obvious way in which they could be brought into more productive use is an empty home tax (or any property tax). The problem with such a tax is that it could precipitate a massive fall in residential property values, which could undermine many financial institutions there.

        Its surprisingly hard for Chinese people to move within China thanks to the Hukou system of permits (and also other cultural reasons, China is still very much a ‘who do you know’ culture which makes it very hard to get a job or set up a business if you are not a ‘local’. Loosening this up could have significant benefits, but I think the CCP is also aware that free movement could result in all sorts of social pressures which can be hard to control, not least a flood of people into the Tier 1 cities. China has actually been quite successful at maintaining a balance of development across the country (necessary of course within a single currency zone), and controls over movement are one of those methods.

        1. Steve H.

          From what I can tell of the Hukou system, it was designed to keep ’em down on the farm, and secondarily as a reward system. But like the U.S., their population recently switched to majority urban.

          I agree that China will keep restrictions on free movement, but there are indications of policy shift on urbanization. If the rural population density increases enough it is no longer rural. More to the point, Qiao Liang sure looks like he has a world-class understanding of the military-economic dynamic, and is a primary driver of increasing industrial production to offset U.S. military expansion.

          This means a policy shift toward urbanization, based on keeping rural population stable at a level capable of providing sufficient agricultural needs. That keeps the caloric energy base of the people decentralized and unorganized. The other side of the coin is increasing population density in the cities, which has been happening.

          They also removed controls on the birthrate, which had been stabilized. Population increase had been slowed to nearly stable. But the death rates have been increasing. Call me cynical, but China historically hasn’t been coy about increasing death rates in the service of policy. What I’m seeing is increased labor supply in the cities, coupled with a willingness to crush dissent by being able to kettle the unrest.

          1. PlutoniumKun

            I’d agree with pretty much all of that – although I think the Hukou system is less to do with keeping them on the farm, but keeping the urban working classes in a sort of ‘elite’ situation. The CCP fears disenchanted urbanites far more than it fears disenchanted rural people, the latter are far easier to control.

            You make an interesting point about rural densities. Many of the most productive Chinese rural areas have a population of around 400 per square kilometre, which is probably more than a typical US exurb. Hence Chinese ‘villages’ can seem more like busy small industrial towns. On the flip side, Chinese urban areas can have very high densities, which is energy efficient and can (in theory) increase entrepreneurialism and innovation, although for all sorts of reasons that only seems to happen in the Tier 1 cities, despite many Tier 2 cities being gigantic by US or European standards.

            I don’t expect the birth rate to increase much – there will be a short sharp increase as many couples will go for a second or third, but all the indications are that Chinese demographics will settle into the Japanese/Korean/Taiwan pattern of very low birth rates, probably below the replacement rate.

            And yes, the Chinese are not coy about having ‘necessary’ deaths. I recall an interesting study years back that indicated that big poor democracies such as India are intolerant of major death events such as famines, while relatively tolerant of high ‘normal’ death rates, while autocracies are the opposite. It will be interesting to see if this holds in the internet era.

            I personally think that the absolute priority of the CCP is control – economic growth is a means to that end, but not the only one. If the model of economic growth buying off dissent fails, they will not hesitate to revert to cruder forms. All the indications are I think that the current crackdown is aimed at this. In the event of a hard landing, they will buy off the urban working and middle classes of the major cities, while using blunt force against the poor in outer provinces and lower tier cities.

            1. Steve H.

              Wow, did that last paragraph make me think about Detroit. There’s a big difference between the Forbidden City and the Kowloon Walled City. Shifting all the scales upward, chosen city/-ies with celestial internal order, many others almost unregulated except for production. A shift of exchange through the borders, areas that breach the Great Wall for exchange.

              In the deepest strategy of international relations, a shift of distinction from the West as reward v punishment. ‘They have the guns, but we’ve got the goods you want.’ Punishment produces paradoxical effects. Positive reinforcement is best to shape behavior.

              Thank you, PlutoniumKun, my understanding is better now than it was three days ago.

  2. Keith

    Today’s nonsense economics does not allow China to make the necessary reforms.

    Western savings rates have approached zero due to the welfare state safety net.

    Western consumers can spend nearly everything they earn.

    China has high savings rates because there is almost no welfare state and they need to save for a rainy day.

    Chinese consumption is impacted by high inequality, low wages and no welfare state.

    The wealthy Chinese are out blowing top end property bubbles in major cities around the world.

    This does nothing for China.

    Using the old economics …….

    High taxes on the wealthy to provide a welfare state for those lower down the scale would have boosted China’s economy. Those that would now be on unemployment benefits would still carry on consuming at a lower level.

    With the new economics, the prosperity of China’s boom has been passed onto the global elite outside China.

    1. Keith

      The world needs demand side reform.

      In a world of chronic over-supply, investors are irrelevant.

      We need to get money into the hands of consumers.

      mmmmmm …….. strong progressive taxation to redistribute wealth from those who can consume no more.

      Now there is an idea.

      1. jgordon

        Looking at economics that way incredibly schizophrenic and dangerous. Just look at the pollution that China is choking on right now and you’ll see that China needs to be making a lot less crap across the board, not being more efficient about distributing its crap into the hands of consumers. Less of everything would by like slamming the breaks on a vehicle that’s headed over a cliff. The economists solution is to slam the accelerator. These people are nuts.

      2. Massinissa

        I kinda have to agree with Jgordon. Instead of getting poor people to consume more we should get the wealthy to consume less. Selling more junk to people may get the ‘economy’ working again but it also weakens our dying planet.

        1. Synoia

          Western savings rates have approached zero due to the welfare state safety net.

          Coincidence is not correlation nor causation.

          If the Chinese Government want to sped some money, and create demand, perhaps they could spend it in cleaning up their environment.

  3. susan the other

    the problem with China is always their impact on the planet… some growth may be better than other growth, but it is always devastating because China is so big. I trust they have an environmental agenda, they seem to – but it is so contradictory not to include it in their economic plans. So far they don’t touch it, like it is the forbidden subject.

    1. PlutoniumKun

      I’m not sure its true that they don’t touch environmental issues. Air pollution is a huge issue in China, its a major source of discontent and the CCP have explicitly stated that it is a priority to reduce it – the main way is to cut back on coal use and invest in nuclear and renewables. Coal use dropped this year for the first time in decades, which shows they are serious about it (it is also related to the need to cut excess capacity). The Chinese are well aware that the model followed by the US, Europe, and Japan was to dirty first, then use the wealth to clean up. They see themselves as entering the second phase. But of course the sheer scale of pollution in China really is terrifying. There are huge institutional obstacles to reform, not least the need to keep lots of industry ticking over to avoid too many angry redundant workers.

      Also, the Chinese are very aware of climate change – its not a source of controversy there, they accept the science and are aware of the issues, even if their approach is engineering first (i.e. lots more dams and irrigation schemes) rather than preventative.

    2. James Levy

      They have intelligent people over there who get it on the environment, and no rational person can look out a window or breathe the air in Beijing and many northern industrial cities without understanding that they need to clean up the environment, pronto. But they are also now talking about tax cuts and deregulation to stimulate the economy because since 1949 the basic pact between party and people is that the people will always have rice in their bowls and they will never lose their jobs for economic reasons. The Chinese police and military are simply inadequate to deal with major uprisings across the country if the economy tanks and people lose their jobs and go hungry. Here in America, the environment loses out to profits and jobs. In China, it will lose out to jobs and stability. I wish that were not the case, but I don’t see it going down any other way.

        1. bob

          Environmental jobz-

          Fresh grad from college goes to work at an environmental firm. “Here’s you sample cups, now go out into the landfill and get some samples. Don’t forget to enjoy the environment.”

          In any honest world, it would be the people responsible for making the mess who would clean it up, working from a trailer, on the site..

          What are these “environmental jobs”? Honestly, name one.

          “environmental engineer”- Shit plant designer.

          1. Steve H.

            – “environmental engineer”- Shit plant designer.

            Historically the former developed from the latter.

            And it is a selective irony that those motivated to work for a clean environment are sent to the most toxic places, whether hazmat sites or D.C.

            Well, that’s in America, I’m not sure about China.

    3. Keith

      How did the West deal with their environmental problems?
      By moving nearly all industry to China with its coal fired power stations.

      It’s a great solution because China’s sky is totally separate from ours.

  4. MyLessThanPrimeBeef

    They are just aping us.

    We do growth, instead of (inequality) reform.

    To make people forget the money stolen from them, we are told more GDP growth will restore that lost wealth.

  5. Knute Rife

    How will China keep the growth coming? The same way certain cells keep the growth coming: by creating cancer.

  6. Knute Rife

    I’m not seeing people in the US failing to save because they have such a great safety net. They are failing to save because they can not afford to.

  7. Fiver

    While the last thing on earth China needs are neoliberal reforms it is equally the case that China is in far greater need of smart GDP than it is of GDP per se (as are we all).

    While we won’t know whether these growth targets are ever really achieved, it certainly appears the leadership elements that had the courage to temper Chinese growth in the first place have been purged, and China will attempt to reflate to now-clearly-ridiculous levels of growth again. The environment just got decisively shoved off the agenda as the political class everywhere refuse to come to terms with a financial class that won’t re-invent itself and what it does into something legitimate and sustainable by re-thinking the built-in requirement for growth ‘no matter what’.

    1. Blink 180

      These rates are comparable to, indeed lower than, Japan’s in its “catch-up” stage in the ’60s and ’70s. What makes them “ridiculous”? China is still in its own “catch-up” stage economically, it’s just REALLY BIG so its economy has reached major-league proportions well before achieving a 1st-world level.

      If you’re trying to say that Earth simply can’t accommodate that much industry, then the Chinese are going to ask where the 1st world gets off keeping their own industry going.

      1. Fiver

        Japan stopped growing in any meaningful way long ago. China has not only overshot the point where a controlled slow-down made sense by a decade, it has now so fully reversed course that the only piece of the sink they’ve not thrown into the effort to regain a position they cannot possibly hold (this way) are the gold faucets that have been sent abroad for a worldly education.

        At the very best it’s a short-term can kick which will leave China in a worse position, and no sink. And has been the case with all the stimulus efforts to date, this will deliver a far, far lower bang for the buck than even the paltry ratio acknowledged, and will be recognized to be such long before the spending even starts to wind down.

        China’s proposed outlet for real investment was the One Belt Road and obviously has been back-burnered due to US sea-trade power preferences (as in, hostility to the whole notion). US financial policy meant Japan could not invest productively outside their home country which is what destroyed Japan via its giga-bubble-smash. China has just bought the last ticket to nowhere, and, as noted, at best we dick around for another year or so – whereas what should’ve taken place was US/European support for the Chinese land-trade project, something which would’ve added real economic value to scores of countries and cities along the proposed routes. Now, with TPP etc., China is trapped in a pot with a ton of fertilizer and nowhere to go.

Comments are closed.