China’s Li Walks Knife Edge on Growth as ‘Graver’ Risks Loom

  • Expansion target set at ‘around 6.5%, or higher if possible’
  • Premier cites global risk of protectionism and deglobalization

Premier Li Keqiang struck an upbeat note on China’s slowing expansion and rising debt Sunday even as he flagged the specter of "graver" internal and external challenges ahead.

Systemic risk is under control and economic fundamentals remain sound enough for the government to set a 2017 growth target of "around 6.5 percent, or higher if possible," Li said in his work report to the annual National People’s Congress gathering in Beijing. Economists surveyed by Bloomberg project 6.5 percent expansion this year.

Li warned of profound changes in the international political and economic landscape with rising protectionism and deglobalization, and said policy makers must be fully alert to building domestic risks from shadow banking to bond defaults and internet finance.

Challenges include a faster pace of U.S. interest rate hikes pressuring capital outflows and the yuan, and the risk of trade friction with the world’s biggest economy should President Donald Trump follow through on campaign pledges to take a tough stance. He also cited mounting downward pressures on growth and serious challenges from excess industrial capacity, an overhang of housing inventory in small cities, and environmental degradation.

"They’re walking a knife edge trying to keep growth at 6.5 percent while reining in the risks built up during the long credit boom," said David Dollar, a senior fellow at the Brookings Institution in Washington and a former U.S. Treasury attache in Beijing. "The targets sound like a compromise."

Focus is shifting to ensuring stability before a twice-a-decade leadership transition later this year. Communist Party leaders repeatedly emphasize the need to maintain control before the conclave. Li reiterated that maintaining stability is crucial and noted that commercial banks have high capital adequacy ratios and provision coverage.

Read More: Xi Stresses Reining in Systemic Risks as Leaders Gather

Restructuring the economy away from investment-led growth remains a formidable task that’s at a critical stage, Li said. Policy makers will further cut excess capacity in steel and coal and target policies to reduce an oversupply of housing in smaller cities, he said, adding that regional growth prospects are diverging and the fiscal imbalance is becoming great.

"Like the struggle from chrysalis to butterfly, this process of transformation and upgrading is filled with promise but also accompanied by great pain," Li said. "It is urgent, formidable, and complicated. We should press forward with courage and get the job done."

Read More: China Targets Growth of About 6.5% Amid Push to Cut Risk

The report also reiterated prior pledges that monetary policy will be "prudent and neutral." China lowered some economic targets and left others unchanged:

  • M2 money supply growth forecast was lowered to about 12 percent from 13 percent
  • Retail sales growth goal was reduced to 10 percent from 11 percent 
  • Fixed-asset investment growth estimate cut to about 9 percent from around 10.5 percent
  • Consumer price index forecast unchanged at 3 percent increase

There was a shift from last year in comments on the yuan, with language on keeping the yuan stable dropped from its prominent position in the 2016 report. The “exchange rate will be further liberalized, and the currency’s stable position in the global monetary system maintained," Li said. Last year’s report said the market-based rate-setting mechanism will be improved "to ensure it remains generally stable at an appropriate and balanced level."

"Leaders are dropping the commitment to keep the yuan ‘level’ stable, and only committing to have it occupy a stable ‘position’ in the system," Bloomberg Intelligence analysts led by Chief Asia Economist Tom Orlik in Beijing wrote in a note Sunday. "That’s a big difference."

Li, a Ph.D. economist, cautioned that global growth remains sluggish just as protectionist threats are rising. There are many uncertainties about the policy direction of major economies and their spillover effects, and those factors that could cause instability, he said.

"The leadership will face a difficult balancing act during 2017 as they try to keep the economy on an even keel amidst mounting domestic economic and financial imbalances,” said Rajiv Biswas, Asia-Pacific chief economist at IHS Markit in Singapore.

— With assistance by Kevin Hamlin

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