China's ‘Hard Bones’ Reform-Drive Seen Leaving Expansion Intact

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  • Policy makers signal tempo of reform will accelerate next year
  • Goldman Sachs, Morgan Stanley see positive momentum for change
Assessing the Health of China's Economy

China’s reform drive is winning plaudits from economists who are increasingly confident that excesses in the world’s second-largest economy can be tackled without derailing growth. 

Faced with a debt pile rising toward three times annual output, a property market showing signs of turning, and entrenched interests slowing long-needed reform of state enterprises, China’s top officials are signaling that the tough jobs can’t be put off much longer.

People’s Bank of China research director Xu Zhong said at a conference in Beijing Thursday that after four decades of reform and development, most low-hanging fruit has been picked. What remains involves the hard stuff, like meaningful governance changes to state-owned companies and overhauling how local government is funded.

China must “bite the hard bones,” Xu said at the Caixin Summit. Reforms in the new era must break through the “psychological comfort zone,” he added, referencing President Xi Jinping’s heralding last month of a fresh period in the country’s of development in history.

Read more: For Global Economy, Slowdown in China Couldn’t Be Better Timed

As that sentiment becomes increasingly widespread, economists at Goldman Sachs Group Inc. and Morgan Stanley are nevertheless upbeat that the economy can address its reform challenges without undermining the expansion.

Global investors have been buoyed by the solid year that China’s economy has put in, setting it up for potentially the first full-year acceleration since 2010. However, even optimists see a slowdown next year amid efforts to rein in excess borrowing and tame the property sector.

Read about estimates of China’s first full-year acceleration in seven years

Economists surveyed by Bloomberg estimate real gross domestic product growth of 6.4 percent next year, down from a projected 6.8 percent this year. Just how much debt-slashing goes on next year matters far beyond China, according to Goldman Sachs analysts led by chief Asia economist Andrew Tilton.

“The policy challenge for 2018 will be to move ahead on risk reduction and key reforms without too much of a slowdown,” Tilton wrote in a note Thursday. “Given that roughly half the world’s investment spending and more than a quarter of global growth occur in China, how its policy makers manage this balancing act remains central to the health of the world economy.”

Goldman Sachs forecasts a 6.5 percent gain in 2018, revised higher last month from a prior estimate of 6.3 percent.

In October, Xi conspicuously dropped a previous Communist Party pledge to double 2010 output, signaling a fresh focus on the quality of economic growth rather than the mere adherence to nominal targets. While officials haven’t yet detailed economic policy for next year -- that’s due in December -- signs of seriousness of purpose have emerged.

Read here how Xi’s economic aide is poised for a key role in debt cleanup

And among other policy makers, the mantra now is that preventing systemic risks in the banking system is the key priority. Data for October also show that the pace of increase in credit aggregates is slowing, with M2 money supply growth now at a record low. While actual deleveraging isn’t happening yet, officials point to this as progress.

The PBOC’s current focus is still on preventing financial risks and supporting the real economy, Yin Yong, a deputy governor of the central bank said in an interview Thursday on the sidelines of the Caixin conference.

Efforts to rein in a frothy property market have also won the approval of the the International Monetary Fund. Authors of a paper released by the Washington-based fund this week said that the authorities’ use of macroprudential policies is “broadly appropriate.”

China’s total debt will increase to 292 percent of output in 2019 and 328 percent in 2022, up from 162 percent in 2008, according to Bloomberg Economics estimates.

Still, Morgan Stanley economists including Chetan Ahya wrote in a report this week that China should nevertheless achieve a “near-stabilization” of its debt-to-GDP ratio by late 2019, and achieve high-income status by 2025.

"Confidence in our thesis has increased over the past few months considering the better-than-expected progress thus far and the continued strong emphasis on ensuring ‘sustainability’ of growth," they wrote.

— With assistance by Yinan Zhao, Jeff Black, and James Mayger

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