In China, economic policies must be based on long-term view

International Monetary Fund managing director Christine Lagarde predicted at the end of 2015 that global growth in 2016 would be “disappointing and patchy”, blaming rising US interest rates, the economic slowdown in China, persistent financial fragility in several countries and lower oil and commodity prices.
Sure enough, on Monday when markets opened for the first time in 2016, the Shanghai A share market fell 7 per cent, which was repeated on Thursday, dragging global stock markets down with it.
The dominant story in 2015 was the slowdown of the Chinese economy and its impact on global commodity prices, including demand on luxury goods. Would this trend continue into 2016?
The “IMF 2015 Article IV” consultation on China, arguably the best available official “health-check report”, found in August that China was “transitioning to a new normal, with slower yet safer and more sustainable growth”.
Growth in China in 2014 fell to 7.4 per cent and was forecast to slow further to 6.8 per cent in 2015. In October, the IMF World Economic Outlook forecast was 6.3-per-cent growth for 2016. Not bad by any standard, but slower than India (7.5 per cent), currently the darling of foreign investors.
There are good reasons for being cautious because of the rising risks. Foreign media reports on the Chinese economy are almost uniformly pessimistic. Not only do they think there will be a hard landing, several analysts think a financial crash is inevitable. The facts are quite clear on the risks.
First, between 2008 to 2014 China’s private debt to gross domestic product rose 73 per cent.
The famous 2009 book by Carmen Reinhart and Kenneth Rogoff, “This Time Is Different”, suggested that fast-rising private debt was the best indicator of financial crises. In the last five years, Chinese debt has grown fastest in terms of total debt.
Second, the economy is clearly slowing, with both manufacturing and recently service sector indicators showing negative growth or slowdowns.
Third, since July, and despite market intervention, the stock market index is still signalling downwards. Bank of America Merrill Lynch analysts are predicting a Shanghai Composite Index level of 2,600 for 2016, compared with a peak level of 5,178 in June and current levels of 3,100.
Fourth, there are capital outflows and concerns on yuan depreciation.
On the plus side, proponents argue that so far the labour market has remained resilient because of the shift towards a more labour-intensive service sector. Household consumption has remained fairly firm, while inflation has been flat, helped by lower commodity and energy prices.
Unlike in advanced countries, Chinese fiscal policy has much more room to manoeuvre, because total government debt was still less than 60 per cent of GDP at the end of 2014. By allowing more interest-rate and exchange-rate flexibility, the room to use monetary policy by the People’s Bank of China has been strengthened.
Despite concerns about the rising level of non-performing loans, the largely state-owned Chinese banking system has adequate capital to absorb these and those of the shadow banks, which are slowly but surely being brought within the regulatory network.
The latest available data show that credit and total social financing has decelerated, but there are no signs of abnormal illiquidity or debt deflation, since the property market has shown some signs of an uptick in first-tier cities.
On the external front, the balance-of-payments current account remained in surplus at 2.1 per cent of GDP, which offset the capital outflows as indicated by the loss in foreign exchange reserves.
Because the economy is so large, looking at China requires a longer-term perspective than normal. The “new normal” is that the Chinese economy is slowing naturally as the economy grows larger and the median age increases.
Under the 13th Five Year Plan, the economy is being retooled to become driven by domestic consumption, innovation and service, an open economy based on social inclusivity and environmental sustainability.
The mantra on the supply-side adjustment is all about getting rid of excess manufacturing capacity and moving to energy and resource efficiency. There are indications that China will also contribute towards global public goods.
All these aspirations must be achieved within the context of social and financial stability. No economy in the world has attempted all these ambitious goals simultaneously without some trade-offs. In such a massive transformation in scale and a short time frame, some economic, financial or political pain is inevitable.
Seen from this perspective, the key question for China is whether the economic trajectory is J-shaped or L-shaped. In other words, are the reforms aiming for a short correction followed by a more sustainable long-term growth, or will China join the rest of the world in a global secular stagnation phase?
China’s debt problem is almost unique in that it is largely a domestic debt overhang, with state-owned banks lending mostly to state-owned enterprises with no net debt owing to foreigners. I have argued that since local governments and state-owned enterprises still own considerable net assets, now is the time to rewrite the national balance sheet with debt-equity swaps to cut back the debt and restore balance in the corporate leverage situation. The state-led system can deal with its state-driven debt problem.
 But one factor to consider in the current system is whether the political cycle is in sync with the economic cycle. The anti-corruption campaign, designed to restore integrity and trust in the cadre system, has now pulled in a number of businessmen, which creates uncertainty over whether it is “business as usual”.
The level of the stock market index is only an indicator of the |complex mix of investor greed and fear. Just as GDP is no longer |adequate as a benchmark of economic progress, policies and business decisions benchmarked against a stock market index can only be wrong.
Tough decisions will have to be taken in 2016 to ensure the long-term aspirations under the 13th Five Year Plan can be achieved.

Andrew Sheng is distinguished fellow at the Asia Global Institute, University of Hong Kong.