China Walks a Tightrope as Its Growth Rate Declines
Despite Slow Global Growth, Deflationary Pressure and Weak Trade Expansion, China Could Still Have the Tools to Avoid the Worst
High stakes: A residential construction site in Beijing, China, in September 2014. GETTY IMAGES
China faces a host of social, financial and economic challenges, but fears of a hard landing are increasingly giving way to the notion that it will be able to manage an orderly decline in its growth rate.
While the world’s second-largest economy still has to negotiate a tough balancing act amid slow global growth, deflationary pressure and weak trade expansion, its large foreign-currency reserves, varied policy tools and incremental approach have convinced many investors—at least for now—that Beijing can avoid the worst.
ANALYSIS
“I think people have become more comfortable with a gradual slowdown in China, although there are still tail risks,” said Andrew Polk, Conference Board economist.
Among those tail risks: Steel, cement and other heavy manufacturing industries remain awash in overcapacity—the result of years of unfettered investment and easy-money policies put in place after the global financial crisis—even as factories have weathered 34 consecutive months of price declines amid rising labor costs.
And China’s real-estate market continues to swoon, leaving empty residential towers ringing many Chinese cities. Although prices are no longer dropping as rapidly as they were several months ago, property market woes are among China’s biggest economic headaches given the sector’s importance. Property accounts for 25% of China’s gross domestic product when construction, appliances and related industries are included.
China’s downshifting after decades of double-digit economic growth has rattled large swaths of Latin America, Africa and Australia, which have prospered by shipping copper, iron ore and other raw materials to Chinese factory floors at high prices. Crude-oil prices have fallen 59% in dollar terms over the past six months, among the sharpest declines in history, dovetailing with price declines for a host of other global commodities.
China’s economy grew by 7.3% year on year in the fourth quarter and 7.4% in 2014, its slowest annual pace in nearly a quarter of a century. Economists expect growth to slow further in 2015.
In a slower-growth environment, monetary policy will remain a challenge for Chinese policy makers, and their ability to get it right will have significant implications for global growth.
For much of last year, the People’s Bank of China relied on “targeted easing” policies, hoping to chip away at overcapacity and bad debt while funneling credit to entrepreneurs, farmers and other sectors earmarked for growth. As more economic arrows pointed down toward year’s end, however, the central bank blinked, leading on Nov. 21 to its first rate cut in over two years.
Expect this tightrope walk to continue as China tries to guide economic growth down without letting output slow too aggressively. Ideally, moderately slower growth in China, relatively flat economic prospects in Europe and a recession in Japan will be offset by stronger U.S. momentum. If China slows more than expected, however, the delicate balance could be upended.
‘Even $4 trillion in reserves can be blown through very quickly’
China is taking steps to tackle its long-festering local-government debt problem, fueled by vanity infrastructure projects and a central government that saddles local governments with large social burdens without always providing a commensurate share of tax revenue. Local-government debt rose to 17.9 trillion yuan ($2.88 trillion) in June 2013, compared with 10.7 trillion yuan at the end of 2010, according to China’s National Audit Office. While China still has enormous foreign-exchange reserves, the sharp rise in overall debt—now estimated at 250% of GDP—has set off alarm bells.
“Even $4 trillion in reserves can be blown through very quickly,” said Randall S. Kroszner, a University of Chicago Booth business school professor and former Federal Reserve governor.
New rules require local governments to give an accurate accounting of their off-book debt—it isn’t clear whether this will be publicly disclosed—as Beijing attempts to work down the overhang with tighter supervision and new revenue sources, including a trial municipal-bond program. Economists expect progress to be slow, but a more transparent financing environment ultimately could provide more opportunities for overseas securities firms and investment banks.
This year should also see a continuation of President Xi Jinping ’s aggressive anticorruption campaign that saw former Politburo Standing Committee member Zhou Yongkang expelled and arrested for committing adultery, taking bribes and leaking state secrets. Mr. Zhou is the highest-ranking official toppled for corruption in recent history.
While some analysts believe the campaign’s primary objective is to strengthen Mr. Xi ’s political hand, it could pave the way for further economic reform. “Xi Jinping made good progress in consolidating power,” said Bank of Tokyo-Mitsubishi UFJ researcher Cliff Tan. “This will make it easier to make progress against resistant local leaders [in 2015],” he added.
Beijing made some progress on reform toward the end of 2014. Interest-rate liberalization edged ahead, an outline of a bank-deposit insurance plan emerged, and the government started to needle state-owned companies to reduce management pay, introduce more private capital and sell off some units.
China’s Communist Party is vigilant about maintaining its grip on power, however, and is well aware that reforms can create new winners and losers, even as it recognizes that it must shift the economy away from investment toward consumption and services to maintain longer-term growth.
China’s incremental approach—codified in the “crossing the river by feeling the stones” phrase attributed to former leader Deng Xiaoping —has exceeded expectations, allowing the Communist Party to navigate planning inefficiencies, corruption, patronage and financial strains. Increasingly, as China grows and becomes more globally integrated, it will be in the world’s economic interest as well as Beijing’s that it continue to feel the right stones.
Write to Mark Magnier at mark.magnier@wsj.com
