China Shows Economic Resilience In The First Quarter by Dan Steinbock, Difference Group

Despite international skepticism, China’s first-quarter data suggests economic resilience amid global challenges, while structural transition prevails in the medium term.

According to new data, China’s economy grew by 6.7 percent year-on-year in the first quarter of 2016. While it reflected the slowest quarterly growth since the global financial crisis, some key indicators such as fixed-assets investment growth and retail sales suggest that the economy is stabilizing.

In the past three months, the performance of the Chinese economy has steadily improved as exports and industrial profits have returned to growth, manufacturing is picking up and power use is accelerating.

The current leading sectors, including Internet-related industries and advanced manufacturing, signal fast growth. In turn, investment in the property sector grew 6.2 percent.

While there are multiple signs that the slowdown in the economy is “bottoming out,” complacency is not an option. Domestically, the ongoing transition from investment to consumption cannot come without volatility. In the advanced economies, stagnation is causing deceleration of growth across emerging economies.

The importance of China’s structural transition

Nevertheless, some international observers believe that, as Reuters put it, the “Chinese economy shows signs of debt-fueled recovery.” The rebound is seen as fueled by a surge of new debt, especially in factory activity, investment and household spending. The claim is that Chinese policy authorities are navigating the economy “out of a slowdown through massive stimulus, rather than structural reform.”

Similar concerns motivate CNBC’s question: “Are traders overestimating [the Chinese economy’s] health?” Yet many observers actually expected worse results. A week ago, Morningstar thought that China’s “first-quarter GDP could look ugly.”

How valid are these concerns? Well, the idea that China has rejected efforts at structural reforms is simply invalid. In the past few years, Chinese President Xi Jinping’s priority agenda – the “Four Comprehensives” – has become the grand blueprint of the new five-year plan. One of these key tasks is to “deepen reform,” which requires reducing government’s role by increasing market power.

Nevertheless, the agenda does irk many international commentators in the advanced economies because, due to their ideological worldview, they reject the idea that the Chinese economy can transition to its next stage without a political transformation. Consequently, even positive economic news is occasionally portrayed in a context of impending doom.

The role of fiscal and monetary easing

In the past few years, Chinese Premier Li Keqiang has pushed structural reforms to support a medium-term rebalancing toward consumption and innovation. He has shunned another huge stimulus, which would contribute to government debt, favoring targeted fiscal measures instead. Finally, he has promoted gradual deleveraging to reduce local government debt, which accumulated after the 2009 stimulus.

Like fiscal policy, monetary policy has sought to support demand. Since 2014, the People’s Bank of China (PBC), the central bank, has cut benchmark lending rates six times, while lowering banks’ reserve requirements and injecting liquidity into the financial sector, hoping to maintain lower borrowing costs.

It is not the case – as some observers argue – that “debt-fueled growth” has only been possible because of current fiscal and monetary policies. In their current form, the latter were not the first preference of Premier Li or PBC Governor Zhou Xiaochuan. Yet, as policymakers, both Li and Zhou must take into account domestic trends and global constraints as they implement policies that make most sense in a challenging environment.

More importantly, the current massive restructuring effort suggests that the central government will no longer tolerate new debt-taking. In the next five years, China’s steel sector plans to reduce capacity by 100-150 million metric tons, while the coal mining sector will cut capacity by 500 million tons, with another 500 million tons to be restructured in the next 3-5 years.

If current overcapacity is reduced by 30 percent in targeted sectors, these cuts would translate to layoffs of up to 3 million workers in the next two to three years.

The restructuring challenge

Neither the restructuring nor structural transition can or will happen without pain. As problem assets mount, the profitability of Chinese banks is likely to decrease in 2016.

At the same time, the problem assets ratio at major banks has risen from about 4 percent to over 5 percent and the worst will only ensue in the next year or two as the restructuring will take off in ailing industries and troubled regions. With structural reforms, these challenges can be managed, however.

Unlike most advanced economies, China is engaged in far-reaching reforms. Due to the constraints in the international environment, the latter cannot move as fast as policymakers initially hoped, however.

Today, China is strengthening but the global environment is deteriorating. Recently, the IMF cut the 2016 global economic growth outlook to 3.2 percent. Concurrently, it upgraded China’s growth forecast by 0.2 percentage points to 6.5 percent, thanks to the progress of the economy in the first quarter.

China’s new GDP range target of 6.5-7 percent is a balancing act. It does not reflect a choice between either reforms or deleveraging; both are necessary. That will ensure greater flexibility amid deceleration at home and stagnation in the West.

The author is the founder of Difference Group and has served as research director of international business at the India, China and America Institute (US) and as visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see http://www.differencegroup.net 

The original version was published by Global Times on April 18, 2016.

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