The macro-control needed for Chinese economy

According to the Chinese economic data released in July, contradictory trends can be observed: on one hand, statistics including GDP, PMI, currency supply growth rate, total social financing, export, urban construction investment bond yield, etc. shows a improving momentum; on the other hand, electricity generation, average daily coal consumption, cement output, price of bulk commodity, land transaction and the like indicate a weak economy. Which of the two statistics can represent the future trends?

The economic situation is far from optimistic

In my view, the later is more accurate. To a large extent, currently the stabilizing economic statistics are the result of increasing leverage and capacity instead of economic structural reform. According to the assessment on IMF recent work report, the growth pattern of China has been kept since the global financial crisis in 2008 and is unsustainable.

In particular, there are three short-term driving force for economy stabilizing:

First is the array of micro-stimulation conducted by the government, such as investment in affordable housing, pledged supplementary lending (PSL) and various local stimulating policies. These stimulations bring construction investment of May and June up to 27.9% and 22.4% respectively; while total affordable housing construction spending from January to June gains an increase at 30.2%, much higher than the 8.5% from January to May.

Second is temporary recovery of export. Export soared by 14% in July, exceeding the market expectation significantly. To some extent, the situation indicates the influence of outer economy recovery, particularly that of U.S. economy. It also shows some impact from technical factors, such as a low base, and arbitrage trading driving from RMB appreciation.

Third and the most important is the enterprises’ behavior of temporary increasing in inventory. For example, key steel enterprises are having 20% more inventory than in the same period last year. Considering the data, year-on-year increase of finished goods accumulation of above-scale industrial enterprises growth from 6.8% by the end of the previous year to 12.6% by June; meanwhile, PPI recovered from -2.3% of March to -0.9% in July.

Such short-term positive progress fails to lead to essential improvement of the structural defects in Chinese economy. Temporary economic stabilization still relies on investment, resulting in continuing accumulation of excess capacity. Excess capacity reduces return on investment and does no good to the improvement of enterprise operational cash flow. A great number of zombie enterprises survive on debt extension, making debt leverage ratio continue to rise.

The long-term structural issue is the very reason for the worsen situation; the economic stabilizing in the second season is likely to be temporary and unsustainable.

First, the export rebound lack a stable basis. The data of China’s export delivery and port capacity cannot be deemed as optimistic. While with European and Japanese economy trapping in recession, U.S. economy probably facing a flat future and RMB keeping appreciation, China’s export is difficult to keep a strong growing momentum.

Second, real estate industry may welcome an important turning point in medium and long term. It loses its traditional pulling power on economy.

The third and the most important is that, as there is little possibility for economic demands to recover rapidly, and due to the high costs of relative inventories, the weak inventory increase in the second quarter is likely to reverse in the third quarter.

Governmental policies

Under such conditions, the stimulating policies made by the government is counteracting in a large part: some measures eliminates potential investment, for example, reconstruction of sheds into housing is unhelpful for the sales of commercial housing; some deteriorates excess capacity and debt burden, for example, the conflicting programs of emerging industrial zones or industrial planning of various areas; some measures increase capital cost and squeeze out private investment. Therefore these micro-stimulation policies stimulate the economy but soon end such effect. And their positive financial effect is marginally decreasing.

The situation indicates that before the reform achieves essential progress (the core aim is to establish constraint mechanism for governmental and state-owned economic entity), economy growth rate and financial risk reduction cannot be achieved at the same time.

In such dilemma, it is the strategic framework for economic policy decision rather than the decision on best stimulation scale or method that should be examined. This term of the administration is of great ambition and deserves people’s high expectation. Therefore, the judge for the economic landscape should be made from the view of long-term planning.

What is the highest standard for economic decision making in a vast vision? The answer may be to protect the bottom line of keeping free from systematic economic crisis. As long as crisis does not occur, China earns precious time to conduct profound reform of social economy system and enjoy the advantage of backwardness, continuing the journey to catch up with advanced economies.

To protect such bottom line, debt bubble can no longer be allowed to continue expanding and resource allocation can no longer be allowed to continue flowing to excess industries and zombie enterprises. This requires tolerance for low economic growth, restricting credit stimulation and investment drive. From this perspective, lowering objective for economic growth is the first step. Any economic growth priced ineffective investment and rise in debt leverage rate does more harm than good. The latest IMF work report clearly suggested that China should lower economic growth objective for 2015 to 6.5%～7%, which pointed out the right direction.

Of course, Chinese economy must prevent the risk of excessive stalling. As reducing economic growth, constraining local governmental investment impulse, policy makers may consider more aggressive fiscal and monetary policies. Expansionary fiscal deficits primarily involve tax breaks in China. Such measure may be the method to stimulate economic growth with the least transaction costs. Monetary policy should consider to reduce deposit reserve ratio and interest in advance so as to release the financial resources for private economy. And the greatest difficulty is reform, particularly the reform for the government itself. Enhancing constraint for local governments and state-owned economy relies on constraining methods rather than monetary policy; it is a necessary prerequisite for the establishment of all measures mentioned above.

Published on FT Chinese | 2014-8-28