China's Growth Addiction Leaves Deleveraging in Back Seat

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Workers on a construction site in Beijing.

Photographer: Tomohiro Ohsumi/Bloomberg
  • Baseline of 6.5% GDP growth through 2020 curbs policy scope
  • More fiscal, monetary support is coming, as is more debt

Rule No.1 in China’s blueprint for the next five years: "give top priority to development."

That’s the word from Premier Li Keqiang’s work report delivered Saturday at the start of the annual National People’s Congress in Beijing. Li acknowledged there would be some difficult battles ahead as he outlined plans to clean up the environment, boost innovation, further urbanize and cut excess capacity in industries like coal and steel. Yet the firmest target remains on the one thing he has the least control over -- the nation’s economic growth rate.

For 2016, a 6.5 percent to 7 percent growth range was outlined, with 6.5 percent pegged as the baseline through 2020. That would be less than last year’s 6.9 percent rate, the slowest growth in a quarter century. To reach the new target, the government will permit a record high deficit and has raised its money supply expansion target. The upshot: debt grows even as growth slows.

"The risk is that if stimulus is accelerated but reform continues to lag, the government could end the year with growth on target but even bigger structural problems to deal with," Bloomberg Intelligence economists Tom Orlik and Fielding Chen wrote in a note. The report "confirms that the focus is firmly on supporting short-term growth, with the deleveraging can kicked further down the road."

Li’s plan suggests debt may rise to 258 percent of gross domestic product this year, from 247 percent at the end of 2015, they estimate. Li signaled the prospect for more debt days after Moody’s Investors Service lowered its outlook on China’s credit rating to negative from stable because of a surge in borrowing.

"Development is of primary importance to China and is the key to solving every problem we face," Li said in the work report. "Pursuing development is like sailing against the current: you either forge ahead or you drift downstream."

Communist Party leaders are trying to restructure the economy without causing any social shocks that could spark unrest and jeopardize almost seven decades of one-party rule.

"Ambitious growth targets mean plans for expansionary macroeconomic policies such as a higher fiscal deficit and generous credit growth, while the approach to key areas of reform, including SOEs and cutting excess capacity, appears timid," said Louis Kuijs, chief Asia economist at Oxford Economics in Hong Kong.

More insight into China’s plans may be forthcoming as the annual gathering of the largely rubber-stamp legislature unfolds. Finance Minister Lou Jiwei Monday gave details on a plan to change the income-tax system and said it’s necessary to increase government borrowing to help other parts of the economy reduce their debt load.

"When society is deleveraging, the government needs to add leverage at a reasonable rate and to advance reform," Lou said. "When the economy recovers, we’ll then consider how the government can cut debt."

Foreign Minister Wang Yi will give a briefing on March 8, followed by People’s Bank of China Governor Zhou Xiaochuan on March 12, and Li returns to give the closing press conference on March 16.

Here are some of the other key targets released by Li at the start of the meeting:

  • CPI increase kept at around 3 percent
  • Creating at least 10 million urban jobs
  • Fiscal deficit-to-GDP expanded to 3 percent, from 2.3 percent targeted last year and the 2.4 percent actual number
  • M2 growth targeted at 13 percent, up from 12 percent aimed for last year, and roughly in line with the actual expansion of broad money
  • Use of "a full range of monetary policy tools"

Thrown together, that spells more stimulus in the pipeline.

"In reality, on top of a higher budget deficit, the PBOC will need to continue aggressive easing to reach the growth target this year," says Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance.

Capacity Cuts

On capacity cuts and state-owned enterprise reform, the targets were more generic.

"We will address the issue of ’zombie enterprises’ proactively yet prudently by using measures such as mergers, reorganizations, debt restructurings and bankruptcy liquidations," Li said in the work report. To help resettle laid off workers, the central government will provide 100 billion yuan ($15.4 billion), Li said, without giving details on the scale or timing of any job cuts.

The earmarking of those funds suggests policy makers are serious about pushing layoffs and compares with the 72 billion yuan spent for the 28 million laid off at state-owned enterprises under Premier Zhu Rongji 15 years ago, said Andrew Collier, an independent China analyst in Hong Kong and former president of the Bank of China International USA. He estimates that 6 million workers could lose their jobs this time around.

"China is struggling between the poles of goosing the economic engine and throttling back the fuel supply, but in the end we are likely to see some gears burn out," he said.

Xu Shaoshi, chairman of the National Development and Reform Commission, the government’ top economic planning agency, denied the overhaul would require massive layoffs. “With the central government’s guidance and careful arrangements by local governments, reducing overcapacity absolutely will not lead to a second wave of layoffs," he said Sunday.

The PBOC is ready to do its part to support the government’s efforts to revamp the bloated SOEs, Governor Zhou said Sunday. “We can make the financial structure better fit structural adjustment policies that tackle the issues of overcapacity cuts, leveraging and inventory de-stocking,” he said.

If enacted, the SOE reforms and capacity cuts will raise near-term economic risks, said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong.


Full Coverage: China National People's Congress 2016


"The strategy is to administer a heavy dose of fiscal stimulus to cushion the blow," said Neumann. "Actual fiscal spending could comfortably exceed what is implied by the wider fiscal deficit as Beijing mobilizes fiscal reserves from under spent budgets in the past."

On markets, there wasn’t a lot new in the work report. Li outlined plans to:

  • Make improvements to the exchange rate mechanism to ensure the yuan remains "generally stable at an appropriate and balanced level"
  • Further bond and stock market reform, with the Shenzhen-Hong Kong Stock Connect will be launched at "an appropriate time."

"The bottom line is that the focus has clearly shifted away from reforms and back to supporting growth," said Shane Oliver, head of investment strategy at AMP Capital in Sydney. "This is understandable given softening growth in recent years. But the risk is that in the absence of more productivity-enhancing reforms, the build up in debt will make it harder to meet growth targets."

— With assistance by Kevin Hamlin

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