If China manages to hit its economic growth targets this year, it will do so at a huge cost.
The annual plenary session of the Chinese National People’s Congress (NPC) is always a puzzle for China watchers. The 12-day meeting of China’s rubber-stamp parliament does not do much legislative business and rarely produces surprises.
Yet China’s rulers spare no efforts trying to turn this yearly ritual into a propagandist triumph. Indeed, the NPC provides the Chinese Communist Party (CCP) a rare opportunity to showcase its achievements and signal its economic priorities.
Pessimism over the Chinese economy and a spate of bad news, including the collapse of China’s stock market bubble and the weakening of the renminbi, made projecting confidence even more important this year. But as the top leaders of the CCP wrapped up this year’s session on Wednesday, they had some good news to celebrate.
On the currency front, Beijing appears to have gained a brief respite. Thanks to the heavy intervention by the People’s Bank of China (PBOC), the value of the Chinese renminbi has recovered and the pace of capital outflows in February was roughly half of that in January (when more than $110 billion left China). Of course, improved sentiment in the global financial markets in recent weeks helped bolster the Chinese currency.
But Chinese leaders’ objectives go beyond currency stability. They believe that the most important factor behind the gloomy mood about the Chinese economy is its diminished growth prospects. According to their thinking, the only way to restore confidence in the Chinese economy and strengthen the renminbi is to revive growth.
That was clearly the message of Premier Li Keqiang’s report to the NPC. Contrary to expectations that Beijing would finally embrace painful restructuring and financial deleveraging to reduce the risks of a financial crisis and make growth sustainable, Li proclaimed that China would achieve GDP growth of between 6.5% and 7% for 2016, similar to the 6.9% GDP growth the Chinese government reported in 2015.
To demonstrate its commitment to achieving this target, Beijing has taken two steps. On the monetary front, the PBOC cut the bank reserve ratio by another 0.5 percentage points (to 16.5%) on March 1 (the sixth such cut since February 2015). Each half a percentage point reduction of the bank reserve ratio (the share of deposits banks are required to hold) frees up roughly 690 billion yuan for lending. Offering yet another indication that China will continue to rely on credit to support growth, Li also set a goal of increasing total financing available for investments by 13% in 2016, roughly double the GDP growth rate.
While Li’s announcement that China will increase its deficit spending from 2.4% in 2015 to 3% in 2016 may suggest to observers that Beijing is willing to use fiscal spending to stimulate the economy, the real increase in deficit-spending is more modest. According to Goldman Sachs, real consolidated deficit spending in 2015 was already 3.5% of GDP and, even with the new deficit target, China’s consolidated deficit spending this year will be only 3.8% of GDP, representing a net increase of only 0.3% of GDP, too little to make a real difference.
If China manages to hit its economic growth targets this year, it will do so at a huge long-term cost. First, the overall indebtedness of China’s economy will continue to rise because credit growth will be double that of GDP growth. Second, much-needed restructuring and financial deleveraging will be delayed, allowing massive overcapacity and zombie businesses to undermine the sustainability of China’s growth.
Beijing recently announced that it would cut steel production capacity by 150 million tons and coal by 500 million tons over a three to five-year period. The move involves laying off 1.8 million workers. But this represents only a modest reduction China produced 865 million tons of steel in 2015. Indeed, in his closing press conference, Li acknowledged the problem of severe overcapacity, but he insisted that China would avoid large-scale unemployment because of restructuring.
Li faces a major dilemma. He needs to maintain growth, reduce debt levels, and restructure a bloated economy, all at the same time. It’s an impossible task. At the just-concluded NPC, he and his colleagues put on a brave face and tried to convince the market that China pull this off. While we should wish them good luck, we should also keep in mind that the odds are not in their favor.
Minxin Pei is a professor of government and a non-resident senior fellow of the German Marshall Fund of the United States