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How slow can you go?

12 Jul 2013 By John Foley

For China, 2013 is becoming the year of the credible shrinking GDP growth target. Earlier in the year, the old 8 percent norm was shaved down to an official estimate of 7.5 percent. On Thursday, Finance Minister Lou Jiwei moved that to 7 percent – and said an even lower number was possible. What’s going on? Here’s the lowdown on the China slowdown.

China’s slowdown is real – but relative

While President Xi Jinping has told China’s officials to worry less about GDP and more about quality of life, investors still focus on the crude indication. The official target of a 7.5 percent increase would already have created China’s slowest growth since 1990. The official acceptance of a lower number shows that the old received wisdom – anything below 8 percent puts China at risk of rising unemployment and social unrest – has been discarded.

For China-watchers, 6 percent growth sounds bizarre. It was not that long ago that double digits were normal. But by the standards of the other middle-income countries, China is still doing exceptionally well. The International Monetary Fund expects 3 percent GDP growth this year in both Latin America and the Middle East.

It has three causes

First, demand for exports from China is slowing. June’s 3 percent decline is especially weak, but the average increase over the last twelve months is the slowest rate since the beginning of 2010. A strong currency hurts, as does weak demand. But as China gets richer, it’s natural that the currency rises and that exports based on cheap labour fade away.

Second, economic gravity is catching up. The Chinese workforce is no longer increasing and the pace of urbanisation is slowing because so many people have already left the farms. Of more concern is the decreasing efficiency of investment. A few years ago, only one yuan of investment was needed to add a yuan to GDP. Now it takes almost four yuan.

Finally, the authorities are not trying to fight gravity. The government knows about stimulus; it did a huge one in 2009. With a fiscal deficit of just 2 percent of GDP and total control of the big banks, it has the means. It also controls the statistics, so can basically report whatever number suits. Clearly, the authorities are comfortable with lower GDP growth numbers.

It’s not about credit

China’s growth has been fuelled by borrowing. But there’s no sign that the slowdown has been created by a credit crunch. The official effort to rein in “shadow banking”, loans that do not appear on banks’ books, may hurt; and total social financing, the government’s favoured measure of new money pumped into the economy, has come down recently. But the six-month average of social financing, a good measure of what’s affecting GDP today, is rising.

Still, there’s a monetary problem. Because profitability is falling and leverage has risen, companies have to put more of their profits into servicing debt and less into investment. The government does not seem too bothered. Officials seem to have learned the lesson of the last stimulus: mandated mega-lending leads to wastage and recklessness.

This might be a fairly good slowdown

The key issue is not pace of growth, but the effect on society. There is a good argument that by that standard China’s recent growth has been too fast. The all-out pursuit of more production led to grave environmental degradation and probably encouraged a lax attitude towards corruption.

A slower-growing economy could allow for more investment in things that make China a happier, healthier place over the long run. Those would include cleaner production, genuine innovation and human capital. But some recently announced projects – the world’s largest free-standing building, the longest under-sea tunnel, a flamboyant space programme – suggest old habits die hard.

It’s not a hard landing

Investors’ talk of a hard landing in China is unhelpful. Even GDP growth of 2 percent a year would be quite acceptable, as long as employment remained adequate and social unrest low. Conversely, 7 percent growth with a spike in labour-related protests and bankruptcies would be tough.

Perhaps the best test of a hard landing is whether the authorities appear to remain in control. Deducing that is largely a question of parsing political rhetoric. It’s encouraging that Premier Li Keqiang says growth hasn’t fallen below the minimum acceptable rate, whatever that is.

What seems most likely is that policymakers are biding their time. The tools they have – forced lending, currency depreciation, vast infrastructure mandates – are powerful but they are also rough, and come with uncertain consequences. For now, the mentality of “best left alone” looks about right.


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