A growing economy alone is not enough.
Last week, Beijing cut banks’ cushion money, calling for a 50 basis point reduction to reserve requirement ratios (RRRs). That’s down to 17%, the fifth such cut over the past year.
The move comes just days ahead of the National People’s Congress (NPC), which kicked off over the weekend. The event, Beijing’s annual legislative session, is a major opportunity for China’s leadership to showcase its policy intentions for 2016.
This year’s NPC is especially significant: It is both the year for the unveiling of China’s large-scale plan designed to guide the country’s social, political and economic development through the second half of this decade — the 13th Five Year plan (13FYP). It is also the second-to-last major opportunity for China’s President Xi Jinping to place allies in key government posts ahead of an upcoming transition in the Communist Party next year. The difficulty facing Xi, in the backdrop of the political calendar, is the slowing Chinese economy.
China’s leaders will put on an outward show of confidence at the NPC this coming week. In its work report for the year, the government said the economy would grow in the 6.5% to 7% range this year — a number that would mark a gradual slowdown for China, but a rate enviable in most of the rest of the world. Particularly in 2016.
The leadership intends to use both government spending and cheaper lending through lower interest rates to get there, as the reserve ratio cut this week indicates. The cut was consistent with a message delivered by People’s Bank of China Governor Zhou Xiaochuan last week — that China still has plenty of “monetary policy space” to support the economy and avoid downside risks. The government also set a wider deficit target in its work report – at 3% of GDP, up from 2.3% last year. This number isn’t as high as some in the markets hoped — but does suggest willingness to use deficit spending to boost the economy.
But investors will find little solace in these assurances. Beijing does still have fiscal and monetary firepower to drive growth. But the market is not looking for growth. Or not for growth alone. Instead, it is looking for healthier growth – which would come via clear signs that the Chinese government is channeling its resources appropriately to tackle China’s massive debt burden (estimated at 240% of GDP) and facilitate an adjustment from heavy industry into services and consumption.
Investors would do well to scratch beneath the surface of the headline targets. Beijing is encouraging banks, which now have more capital to lend since the reserve requirement cut, to channel new credit away from dying heavy manufacturing industries and into higher-value added sectors. The government is also sharply increasing fiscal spending to support consumption (by bolstering pensions and healthcare access), innovation (through industrial policy), and environmental protection.
Real progress is already being made: according to recent numbers from China’s finance ministry, the government’s overall expenditure on social security and welfare increased by 17% in 2015 from 2014, for example. And on energy saving and environmental protection—crucial issues for the Chinese leadership today in the face of disastrous air pollution in major cities—government spending increased by 26% last year.
The key challenge for Beijing is to prevent banks from channeling their newfound firepower into failing companies and stagnant projects. That would only extend the level of bad debt in the system, setting China up for an even more painful adjustment down the line. While the NPC will showcase the government’s aspirations, markets will be looking for real signs of follow-through this year.
Nicholas Consonery is director of Asia at Eurasia Group.