If so, this implies further downside risks for the economy and markets in the near term. But such policy measures are necessary now for China in order to avoid much more disruptive outcomes in the future.
The economic policy of the previous Wen Jiabao government is regarded as having been strong on growth but weak on reform. Public sentiment is now especially negative about the 2008 RMB4 trillion stimulus package for causing overcapacity in certain areas of infrastructure, significant fiscal risks due to reckless local government borrowing, inflation, asset bubbles and the threat of bad debt following the huge credit expansion. There now seems to be a consensus that China should tolerate slower growth and focus on structural reform. This is the foundation of the three pillars of Likonomics.
Li has pointed out repeatedly that the room to rely on stimulus policies or government direct investment is not big. This is the pillar of ‘no stimulus’. Relying on government-led investment for growth ‘is not only difficult to sustain but also creates new problems and risks’. In fact, many heavy industries, such as steel, cement and aluminium, are already struggling due to serious overcapacity problems, and the government is downplaying the importance of fixed asset investment in China’s new urbanisation drive.
The days of 10 per cent annual growth are over for China. Growth potential is now around 6–8 per cent. Of course, the government is not completely passive in this regard. Government-led infrastructure spending on energy, water and transportation has been accelerating since the beginning of 2012, but the scale is much more constrained compared with earlier programs. As long as the unemployment rate does not surge, the government is unlikely to adopt new stimulus measures to boost growth. The minimum acceptable growth rate has also shifted down, from 8 per cent at the beginning of last year to 7 per cent now. It could fall further in the coming years.
Li said recently that banks must make better use of existing credit and step up efforts to contain financial risks. Following implementation of the previous stimulus package, China’s total credit had increased from US$9 trillion in 2008 to US$23 trillion by early 2013. Evidence suggests that countries experiencing rapid credit expansion for extended periods always end up enduring a painful economic adjustment. What is more worrisome for China is the divergence in growth rates between credit (above 20 per cent) and nominal GDP (below 10 per cent) in recent quarters.
The PBoC’s recent move to curtail the credit bubble in the interbank market underlines the authorities’ desire to deleverage and reduce future financial risks. This is pillar two. Their actions are a clear warning signal to financial institutions. While the authorities are likely to intervene to stabilise the market if needed, interbank rates could remain high for a long period. Policymakers probably also aim to strengthen market discipline as a preparatory step towards interest rate and capital account liberalisation. This implies that deleveraging is likely to continue and some of the smaller and weaker financial institutions may fail in the coming year.
Li has also advocated reform as likely to pay the biggest policy dividends for the Chinese economy: pillar three. While investors are anxiously waiting for the Third Plenum in the autumn for a clearer outline of economic policies, current policy discussion indicates reforms in the areas of financial liberalisation, the fiscal system, factor prices, land use, administrative controls, monopolies, income distribution and the household registration system — many of which could be approved before the Third Plenum.
Likonomics has some distinctive features. In Japan, Abenomics is about ending deflation and restarting economic growth. Likonomics is about deceleration, deleveraging and improving the quality of growth. Both Abenomics and Likonomics have also somewhat different approaches to the implementation of fiscal and monetary adjustments. But it is structural reforms that will determine the success or failure of both Abenomics and Likonomics. With the Chinese government actively preparing a wide range of reform measures, it will be up to the new premier to prove that he is a decisive leader.
Likonomics policy is exactly what China needs to put its economy on a more sustainable growth path. It is positive for the longer-term outlook of the economy. In the short run, however, such rebalancing and deleveraging point to further downside risks for both economic growth and asset prices, including the exchange rate. Based on an increasingly likely downside scenario, Chinese growth could experience a temporary ‘hard landing’, with quarterly growth dropping to 3 per cent or below within the next three years. But such a slowdown would only be cyclical, and would likely bounce back dramatically soon afterwards.
Yiping Huang is Professor of Economics at Peking University and the Australian National University.
Yiping Huang recently published a Barclays Capital report jointly with Jian Chang and Joey Chew, ‘China: Postcard from Beijing — What to expect from Likonomics?’ (27 June 2013, Hong Kong). In this report, the authors first coined the term ‘Likonomics’.
Sudden spurt of in monetary stimulation is no different from deficit financing. In a country like China where there is political tradition of overplaying successes and hiding failures ( remember great leap forward ), it is important to assess the realites of value creation, which may have well been exaggerated hugely disproportionately. This may be reason for growing growing conditions for discontent and rebellions in Chinese non han provinces. Uighar separatism, which undoubtedly has deep historical context cannot be merely an ethnic problem but a deeply rooted manifestation of economic discontent too. Discontinuation of stimulation will reverse the volume and pace of economic activities will inevitably foment further discontent and Communist Party shall be more challenged in next 3 to 4 years than it is now or ever before. Looking at the Chinese story, it seems global growth has a cyclical pattern. Sometimes some economies go on high growth trajectory for some time then slow down causing flight of capital to greener pastures of which there are many in developing world and under developed countries of Asia, Africa and Latin America. Given the innate nature of capital to achieve and accomplish quick and high returns, international capital shall look for greener pastures away from China and focus on safeguarding their existing investments and mitigating risks due to political instability in China, which could be mitigated by growth under stimulation but cannot be withdrawal of stimulation, which in any case was not sustainable. Communist China is poised to become more and more repressive and seek to check flight of capital by financial sector reforms. Once this happens US and European leverage on China will increase leading to much awaited political reforms in China and shifts in Chinese foreign policies for the better. But till that happens there are chances of much political tension in China and in Asia and Asia Pacific regions.