01 Jun 2018
Is China facing a cyclical or structural slowdown?
One of the records broken at July’s FIFA World Cup related to own goals. In their eagerness to defend players hit their own nets 12 times - more than doubling the figure in 2014.
Mario Mandžukić’s own goal in the final helped to hand the trophy from Croatia to France. It shows even if one has the right cause, striking the wrong target will not bring success.
China’s economy faces a similar risk. The government is said to be easing monetary policy and lifting fiscal stimulus because of an uncertain growth outlook in the second half.
" [China] may be aiming at the wrong target.” - Raymond Yeung
In light of US President Donald Trump’s threats, the same instincts may have prompted Chinese policymakers to do whatever it takes to defend the gross-domestic product target of 6.5 per cent - simply because the figure looks good.
The problem is they may be aiming at the wrong target. If declining GDP growth primarily reflects a drop in growth potential, counter-cyclical measures are the wrong antidote.
China may have a higher and positive output gap. Monetary policy easing is thus inappropriate in this situation. Unfortunately, China’s output gap is rarely discussed by policymakers and analysts.
China’s data cannot support a highly precise estimate of potential growth. Comparing trend versus actual growth offers little insight about the true growth potential.
High frequency data can help. Indicators such as producer prices, industrial utilisation rate and even jobless rate show the output gap has been positive and rising, suggesting that the slowdown in the headline GDP is structural.
The plunge in the labour force and capital accumulation clearly point to a drop in potential growth in China.
This trend can only be averted through productivity improvement, according to the Solow-Swan growth theory. When trend growth declines and output gap is positive, China needs structural reforms instead of pump-priming.
Premier Li Keqiang’s State Council has declared a more proactive fiscal policy stance. These government measures, including the central bank’s policy, are sector specific, be it R&D or SMEs.
The targeted approach appears to support reforms at the micro level. The issue is whether the funds will go to the truly productive sectors, given the track record of local economic agents in regulatory arbitrage.
ANZ Research still believes the People’s Bank of China will not attempt to expand its balance sheet. The large MLF injection on July 23 was followed by a long pause in daily injections.
Another reserve requirement cut, likely in October, will still be misread as easing. A stimulus may shore up sentiment but fail to lift growth potential.
With supply-side constraints, counter-cyclical measures may risk bringing about stagflation and low investment return in the future.
The sorrow of Croatian football may last for a while. A ‘Lost Decade’ can last a lot longer.
Raymond Yeung is Chief Economist Greater China at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
01 Jun 2018
12 Jun 2018