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Analysis
Raise Chinese growth, issue more renminbi bonds

Raise Chinese growth, issue more renminbi bonds

Economy could slide further without stimulus

by Yu Yongding in Beijing

Mon 6 Jun 2016

The Chinese government’s determination to carry through structural reform is welcome, but it is not enough. An equally, if not more, important task is to break the country’s deflationary spiral and stabilise the economy at a rate consistent with its growth potential.

Structural reforms will improve China’s growth potential, but they cannot stabilise the economy. Rather, the solution lies in switching to a much more aggressive fiscal policy.

China’s public debt is just 41% of GDP. Its budget deficit is a mere 3% of GDP. China’s strong fiscal position allows it to run a much larger deficit. In particular, the government should significantly increase infrastructure investment in areas that will feed through directly to the economy, ranging from transport to ‘green’ technology. This would boost growth in the short term by increasing aggregate demand, and in the longer term by improving efficiency.

The need for more aggressive fiscal measures stands in some contrast to the view of an anonymous ‘authoritative person’ who said, in an early May interview with the People’s Daily, that the economic slowdown was not a cause for concern. According to the high-level mystery interviewee, China’s economic trajectory is following an ‘L-shaped curve’, lasting for ‘longer than a year or two.’ Despite this, ‘even without stimulus, given its potential... China's economic growth will not drop to somewhere worth worrying about.’

Indeed, according to most Chinese economists, there is no need for fresh action to buoy the economy. The consensus is that, in a period of relatively slow world growth, China’s potential growth rate is between 6.5% and 7%. In the first quarter of 2016, China’s annualised growth was 6.7%, the lowest since the financial crisis, but still in the mid-point of that band.

However, such views are not convincing. First, China’s producer price index has been in negative territory for 50 consecutive months. Second, its core consumer price index has been hovering around 1-2% for years. Third, surveys by industrial enterprise associations show capacity utilisation is below 70%.

A logical conclusion is either China’s growth potential has been underestimated or its actual growth rate has been overestimated. Whatever version you take, China has been growing significantly below potential. In fact, the economy appears to have slipped into a deflationary spiral. Without stimulus, it may slide further.

Many believe that China’s overcapacity is mainly a result of lack of ‘effective supply’: China has produced too many products no one wants. ‘Supply-side structural reforms’, such as restructuring state-owned enterprises and general deregulation, would allow enterprises to respond better to market signals and ‘zombie firms’ to be closed. However, this argument confuses macroeconomic and microeconomic issues, with dangerous policy implications.

The true priority is that China should raise consumption growth to offset the negative impact of slowing real estate investment and external demand.

Infrastructure programmes would help consumption in both the shorter and longer run. The government’s 13th five-year plan for 2016-20 identified many important infrastructure projects. Financing should be through government bond issuance, rather than bank loans as in the past. China is a high-savings country, with strong household demand for government bonds.

A large-scale issuance programme would deepen the bonds market, by providing additional paper for both domestic investors and foreign investors (including official institutions) which will seek to own Chinese assets after the renminbi becomes part of the International Monetary Fund’s special drawing right from 1 October. This is an indispensable element for development of China’s financial market.

With the right policy mix, China can not only avoid a hard landing and a debt crisis, but lay a solid foundation for sustained growth for years ahead. The rest of the world will benefit from a better-performing Chinese economy. Targeted infrastructure investment linked to sustained bond issuance is the right way to bring this about.

Yu Yongding is a former Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, and a former Member of the Monetary Policy Committee of the People’s Bank of China.

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