Cross the river by feeling the stones, as Deng Xiaoping famously said. But China’s new leaders will perhaps need more method, rather than intuition, in shepherding the rebalancing of the Chinese economy. Despite the 2008 financial crisis and the danger of the developed economies remaining in a tailspin, China has continued to be critically dependent on government-led investment for growth, quite unwillingly. According to The Economist Intelligence Unit, from 2009 to 2013, investment has caused more than half of China’s growth accounting for an average of 5.1 percentage points of growth every year, as compared with 3.2 percent for consumption, 1.2 percent for government expenditure and -0.7 percent for foreign trade.
The much publicised announcement of rebalancing the Chinese economy during the recently concluded Third Plenum of the 18th Central Committee of the Communist Party of China (CPC) called for reducing this unsustainably high dependence on investment. Despite steps to reduce this dependence, investment will add 3.7 percent to China’s economic growth in 2013 and half a point less 3.2 percent in 2014. If the current fiscal firmness continues, in 2016, private consumption could top investment’s contribution to growth and could be down to 2.3 percent by 2018. That makes 2014 the first year in decades when the Chinese economic story will undergo one of the most important transformations – focusing on both growth and reform. The overarching challenge is to end the old ways of seeking growth.
For years, the Chinese policy makers aimed at achieving high Gross Domestic Product (GDP) figures focusing on exports and investment. This made the Chinese economy susceptible to vulnerabilities elsewhere, especially the developed economies of the West – the biggest consumers of Chinese goods. The 2008 global economic meltdown changed that more convincingly than ever before. It is in this context that the much talked about “document on major issues concerning comprehensive and far-reaching reforms” issued after the 18th CPC Third Plenum underlined the need for achieving innovation and consumption led balanced growth and reform. The fact that this policy assertion came from a leadership that will continue at the helm for the rest of the coming decade, makes it only more important.
The major economic theme of this Third Plenum document was giving a ‘decisive’ role to the market. This essentially means advancing market-based reforms to achieve quality growth. The upcoming economic development will hence focus on deepening reform and opening-up, and further pursue structural rebalancing and industrial upgrading. Achieving these require, most of all, a firm monetary policy and structural reforms. China has seen speculative monetary inflows especially during the past two years as reflected in unprecedented surge in country’s foreign-exchange reserves despite dramatically contracting exports. It suggests the influx of hot money instead of long-term, committed investments.
As the document underlined, even at the cost of a few points of GDP growth, China must make sure to realign become a well-regulated, consumption-driven, middle-income economy that brings more benefits of economic growth to its people. It will also provide for more social services such as health and pensions, and secure growth for both China’s and the world economy.
2014 will be the first year to see the full scope of the beginning of China’s fundamental transition in both investments and exports. Unproductive borrowings, especially by large state-owned enterprises, have threatened China’s investment-led growth to go out of control. Among others, it has caused overcapacity in traditional heavy industries, large investment zones without real investments, many unused offices in major cities, not to ignore the heavily indebted local governments.
China has thus acted on a policy of making borrowing costly for large corporations. Since June this year, it has raised the interbank lending rate to discourage borrowings and prevent shadow banking activity. Such a tight credit situation will create more difficulties for the industry by raising its production costs and pressure on wholesale prices. If it leads to weakened growth, job hiring could go down and consumption will also be affected.
China plans to balance the negative fallouts of these steps by removing barriers for private capital, and liberalising and developing the financial sector. To ensure job creation, promoting small enterprises is on cards where small credits will produce more jobs, boost market competition and push innovation.
Indeed, the structural reforms include promoting optimum use of resources through higher taxes on raw resources, charging higher dividends to the SOEs and changes in weighting of the performance evaluation of government officials.
Structural shifts in exports are other changes that China has launched and will achieve pace in coming years. Nonetheless, quality growth means that China’s cheap labour cost advantage will go away sooner than later. This lessening of the lower-end manufacturing competitiveness will be countered by moving up the value chain in exports.
To promote consumption, there are plans to promote urbanisation on an industrial scale. The next year could see accelerated pace of urbanisation and with that, an expansion in demand for financial, education and healthcare services. Increased social security measures are also in the pipeline.
As the recently concluded National Economic Summit from Dec 12-15 decided, better control of local government-related debt by making it more transparent is going to be the other major structural reform.
Fundamental restructuring of an economy of the scale of China is quite likely to throw complex challenges. In any case, it will take years, if not decades. Despite all the rebalancing, export is going to be a mainstay of Chinese economy and any scenario of a weak global demand could push growth and corporate investment down. Domestically, the impact of a tighter monetary policy and all the structural reforms on growth could be larger than expected.
(The views expressed in this article are solely those of the author)
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