Premier Li Keqiang has suggested that 7% is the minimum acceptable rate of GDP growth. However, the latest PMI indicates this could be difficult to achieve, according to the Bank of Singapore.
"Financial markets have developed the unfortunate habit of assuming that China can have whatever rate of growth it wants," says Richard Jerram, Chief Economist, Bank of Singapore. "This might be true in the sense that the data quality is poor and they can publish whatever numbers they choose, but it is not the case in terms of genuine economic outturns."
Jerram notes that the flash HSBC PMI for July fell to 47.7, down steadily from the January high of 52.3. Business confidence is now about as low as it was in 1H 2012 when the government was prompted to loosen policy to support growth. The recent squeeze on shadow banking suggests that the PMI is likely to fall below 2012 lows in coming months.
"Now the policy-makers face a dilemma. They can try to support growth at the 7% target through looser credit or increased infrastructure spending, at the cost of impeding economic rebalancing and hurting their credibility. Alternatively, they could accept growth falling below 7%, with an ultimate concern about social disturbance. Unavoidably, this means the short-term direction of policy is unpredictable," says Jerram.
Jerram adds that ending forex appreciation will give some relief to the export sector, without much impact on domestic rebalancing, so our 12-month target is for USDCNY6.20.
"If the investment-led state capitalist model, fuelled by migration from rural areas, is running towards the end of the line, then we should expect two things. First is that the adjustment to a new model will be difficult and disruptive, even if it is successful. Second is that the growth rate will be slower," says Jerram.
In recent years, excess investment has been running at about 10% of GDP. This is the overshoot compared to Japan and Korea at the peak of their high-growth periods and it is close to the annual increase in the credit-to-GDP ratio over the past four years. The policy focus on reform and reducing financial excess suggest that this over-investment is under threat.
"If we generously assume that only half of the 10% of GDP in excess investment needs to disappear, and similarly generously assume that it can be cut without affecting growth in the rest of the economy, then we can work out what it might mean for growth. Taking away 5% of excess investment in a single year would put growth down to 2% for a year, before returning to a more ‘normal’ 7%. More realistically, taking three years to enact the adjustment would send growth to around 5% over that period."
Jerram says that it is possible that the government finds other mechanisms to support growth while the excess investment drains away, but it is equally likely that cutting back investment has a negative impact on other parts of the economy.
The over-investment and excess credit growth of recent years imply a build-up of bad loans in the system, perhaps in the range of 15-20% of GDP. Despite the recent excitement over deregulating the lower limit for lending, the bad loan problem will be a barrier to deregulating deposit rates.
Jerram says that unless the central government is prepared to bear most of the costs of resolving bad loans, then it will need to protect banks’ profit margins by allowing them to pay low interest rates to depositors, to give them the resources to write off bad loans.
"We could also see good bank-bad bank mergers. Central government finances are healthy, so we are not overly worried about the scale of the bad debt problem."