Recovery from the 2012 slowdown has been weaker than expected. Leadership is hinting at reforms and plans to revisit income distribution as segments of the population move from rural to urban areas.
The pace of recovery
There are indications that China’s recovery from the slow growth of 2012 is weaker than anticipated. Data for January and February— the two months are combined due to the Chinese New Year—showed that industrial production and retail sales increased more slowly than expected. Industrial production in the first two months of the year rose 9.9 percent from a year earlier, the slowest start to the year since 2009. Retail sales for the first two months of the year were up merely 12.3 percent. The slowdown in retail spending was partly due to an official effort to curtail spending on entertaining officials.
At the same time, exports and fixed asset investment are growing strongly, suggesting that China’s expansion is reverting to the old pattern of exports and investment rather than consumer spending. In the long term, this is not a sustainable pattern for China. Fixed asset investment was up 21.2 percent in the first two months of the year. In addition, exports in February were up 21.8 percent from a year earlier, even though there were four fewer working days in February this year than last. Imports actually declined in February, raising concerns that domestic demand is lagging. Particularly noteworthy was a 16.5 percent increase in exports to the EU. This was the third consecutive monthly increase in exports to the EU, the first time this has happened since 2011. Exports to the United States were up 15.7 percent, and exports to Japan were down 6.5 percent.
Recent pessimism about the weak numbers for China’s manufacturing sector was offset, however, by more positive news. It was a relief to learn that a preliminary purchasing manager’s index for manufacturing was up. The index, published in March by Markit and HSBC, increased from 50.4 in February to 51.7, suggesting accelerating growth in the manufacturing sector. In addition, inbound foreign direct investment into China rose in February for the first time in nine months with a 6.8 percent increase from a year earlier. Outbound FDI was up as well and exceeded inbound FDI. The increase in inbound FDI signals a possible revival of foreign business confidence in China’s outlook.
China’s new premier, Li Keqiang, made a surprisingly candid speech about what is needed for China to move forward. He said that he wants to reduce the power of the Chinese government and increase the role of the private sector in the economy.
The future of government policy
China’s new premier, Li Keqiang, made a surprisingly candid speech about what is needed for China to move forward. He said that he wants to reduce the power of the Chinese government and increase the role of the private sector in the economy. According to Li, “it is about cutting power, it is a self-imposed revolution. It will be very painful and even feel like cutting one’s wrist.” He backed up his statements by appointing an economic policy team composed of respected and experienced reformers. Li also made a strong statement about dealing with pollution: “we shouldn’t pursue economic growth at the expense of the environment—such growth won’t satisfy the people.” At a time when smog in Beijing and elsewhere is seen as a significant threat to public health, Li’s statement was welcome.
In addition, head of China’s central bank indicated that he is worried about rising inflation, which reached 3.2 percent in February. He says that the bank’s policy is “no longer relaxed” and “relatively neutral.” Zhou Xiaochuan said that “we will use monetary policy and other measures to hopefully stabilize prices and inflation expectations.” This statement comes at a time when China’s economy is showing signs of sputtering, with industrial production rising more slowly than had been anticipated. However, the central bank is concerned about consumer prices in addition to a possible housing bubble and the rise of non-bank sources of credit. Zhou also expressed concern that some loans to regional governments are not backed by revenue-generating projects and are, therefore, at risk. The central bank set its money supply growth target at 13 percent, which would be the slowest rate of money supply growth since 2000. Zhou is the longest serving head of China’s central bank and, despite reaching the age of 65, is widely expected to be retained after the mandatory retirement age. He has been instrumental in pushing the liberalization of credit markets. His comments suggest that he wants to stabilize prices and the financial system before he departs. For the government, the challenge will be to keep growth going in the midst of a tighter monetary policy.
Meanwhile, Moody’s chimed in with a warning that China’s local government debt is at risk of default. This follows the central bank’s assessment that there might be trouble. According to Bloomberg, local government debt issuance increased by 179 percent from 2011 to 2012 and accounted for 50 percent of corporate bond issuance in China in 2012. It is estimated that local government debt amounts to between 18 and 30 percent of China’s GDP. As local governments cut back on borrowing, this could have a negative impact on economic growth.
Another issue in China concerning credit growth has been the very rapid expansion of the so-called shadow banking system. This has involved the creation of credit outside the formal banking system, often using off-balance sheet vehicles operated by traditional banks. The huge growth of this system played an important role in the country’s economic recovery after the global crisis of 2008–2009, but its large size and lack of supervision worries many observers. They are concerned that the system poses a risk to the economy. Consequently, the Chinese government recently announced that it will require fuller disclosure about off-balance sheet vehicles operated by banks. It will also consider rules that would cap the size of such vehicles. Such rules could curtail credit growth.
Dealing with income distribution
Finally, an important policy issue concerns the rising inequality of income in China. The country currently has a system of residence permits known as the “hukou” system. The permits indicate where a person resides and whether they are urban or rural. Many rural migrants live in big cities, but they are not entitled to many of the services enjoyed by local residents because they are classified as rural. These can include education and healthcare. As such, China has developed a two-tiered system that is a source of considerable tension and potential unrest. Now there is word that the new leadership intends to do away with the hukou system and replace it with a system of national residence permits. The idea is to end the two-tier system and to encourage more rural people to permanently settle in urban areas. Outgoing Premier Wen Jiabao says that promoting urbanization will assist with continued strong economic growth. The transition to a more consumer-led economy will require more urban dwellers with greater purchasing power. The challenge, of course, will be to fund the added government services that will become available to migrants.