Expectation Management and Fine-Tuning in China
2014 GDP growth is in the spotlight despite the government’s efforts de-emphasize the headline growth number and emphasizing structural reforms and environment/resources concerns. Indeed, GDP growth remains the most important indicator and signals the need for balance between growth and reform. China urgently needs a new sustainable growth model as it transforms from an investment and export-driven economy to a consumption-oriented economy. There is widespread consensus that China has no choice but to continue to march forward. Reforms are now entering deep waters after 30 years of “crossing the river by touching the stones”, i.e. small and incremental changes.
The choice of continuous structural reforms at a deeper level implies that growth will inevitably slow down as the country continues to climb up the value-added ladder while spinning off its low value-added industries. Simultaneously placing greater consideration on environment and resources, promoting services sectors and encouraging consumption, while lessening dependence on investment and credit, and rebalancing its trade account will also contribute to slower growth. A “moderate” slowdown is therefore widely accepted by both the policy makers and the public in China.
However, how best to calibrate this “moderation” remains unclear, and has led to market jitters, as a slight slide in growth could mean a significant shock to the economy. How fast and how far the economy is to fall is hard to predict, bringing further concerns and strengthening the momentum of wait-and-see attitudes in the market. If the downward economic trends continues to accelerate, it may become self-reinforcing cycle and spin out of control. A 10 basis point drop in GDP growth implies a decline of about 700 billion renminbi in nominal value and 10 million unemployed. Whether or not the weakening economy can withstand the fall of 20, 50 or even 100 basis points in growth in 2014 is not as clear-cut as claimed.
Given the trade-off between reforms and growth, market opinions on how to balance the two diverge significantly. A popular view argues that China’s economy could self-adjust and that a moderate slowdown would be healthy. That is, the government should actively push reforms regardless of GDP slowdown and leave the market to undergo ‘survival of the strongest’. In our view, this kind of shock therapy might function at certain levels but will bring serious instability and fluctuation to the economy and society in the process. Counter-cyclical policies are decisive to ensure moderate and stable growth with less uncertainty, which could provide a favorable environment for structural reforms.
If a downward cycle materializes, it is hard for an economy to transition smoothly. Reforms will be much easier in a relatively stable cycle. It is also true that, in an upward cycle, policymakers may be reluctant to implement new reforms. If the government stands firmly on structural reforms, the visible hand could maneuver policies against the cycle to make reforms more effective and efficient. The market alone is incapable of accomplishing the task, thus providing some buffers to the economy along with expectation management and fine-tuned policies to cushion shocks on economic growth and employment in reforms is a better strategy.
Proper government intervention to smooth volatility and support relatively stable growth along the road of reforms is critical for success in China’s transition into the new Great Moderation period. Intervention does not mean aggressive stimulus, which has been gradually phased out and transitioning to policy normalization post financial crisis. But it also does not mean no intervention. Indeed, the policy orientation will be fine-tuned continuously to follow economic and financial movements. This will require better communication and more transparency in policies to better manage market expectations to make policies more effective and efficient. Policy communication at this stage needs, in our view, more transparent and clear.
Great efforts have made in China to clarify priorities among a wave of structural reforms. The decision on “Major Issues Concerning Comprehensively Deepening Reforms" announced at the 3rd plenary session of the 18th CCPC in November 2013 outlined 60 specific reform missions in six fields including economics, politics, culture, environment and communist party and highlighted the importance of balancing power between the market and the government to better allocate resources and achieve higher efficiency. The reform framework was further clarified at the annual Economic Workshop in December 2013, setting 2014 policies reform priorities in ensuring food security, pushing economic restructuring, controlling local government debt risk, promoting regional coordination of development, improving the well-being of the public and accelerating the opening-up of China. Reforms were further identified at the NPC this March into five major areas including fiscal reforms, financial reforms, SOE reforms, land reforms and Urbanization reforms. The transition of major reform targets from 60 missions last November to 5 major areas this March, as a result of prioritization of tasks by the central government, reflected a long journey ahead for the ambitious reform.
In contrast, the government's short-term cyclical policies are not that clear. Short-term policy has swung widely over the past year. Policymakers professed no desire to intervene last March, announced a mini stimulus in July, set stable growth as the priority for 2014 last December, hinted that a lower growth rate would be acceptable in March, and expressed concerns about negative pressures on growth and employment in April. The government's confusing messages have made setting proper expectations difficult.
Previously, it is widely known that the upper range of 8.0-9.0 percent was the comfort zone of the government though China’s GDP target had been set at 8 percent year-on-year for 20 years. In other words, 8 percent is the lower bound for growth. However, the market is confused this time whether the 7.5 percent is a lower bound or an upper bound, and what the comfort zone is, what the policy reacting zone is, and how the government will step in to intervene. All kinds of interpretations and guesses thereafter have confused the market, further strengthening wait-and-see sentiments in a weak cycle.
Without clear directions and guidance, the economic adjustments have to follow the old “reactive” pattern rather than being “pre-emptive”, that is, policy announcement and policy coordination have to wait until the bad scenario materializes. Effective expectation management with active fine tuned policy is therefore the key to balance growth and reforms. A clear growth target with clear interpretation and explicit indicators could help alleviate market concerns s and encouraging investment and consumption. In other words, “bottom” management is critical in the period of Great Moderation. Both growth and reform could proceed more smoothly, if the public believes that 7.5 percent year-on-year is the lower bound of growth target by the government and thus the government will intervene if it drops to a certain range, saying between 7.7-7.8 percent year-on-year.
At the same time, preventing overheating is equally important, so an upper range of growth needs be addressed and policy evaluation needs be more frequent and effective. Matching with China’s 5-year plan, it is probably a better idea to set a range of GDP targets for five years, possibly within the range of 7.5-8 percent rather than a definite figure every year, which could well guide expectations in a more efficient manner and boost market confidence. Once this clarification is done, structural reform will win credibility. The market would view short-term policies as supporting by long-term objectives and therefore not associated with deepening of current imbalances.