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The economy's steep uphill climb

By Zhang Ming (China Daily) Updated: 2015-03-16 09:37

Effective capital management tools will buoy tempered growth in China's new phase

Last year the Chinese economy entered a phase that President Xi Jinping dubbed the new normal, which encompasses three challenges: a tempering of economic growth, structural adjustments and the re-examining of problems left by the 4 trillion yuan stimulus package of 2008-09.

To be clear, China's economic rate is going to drop from 10 percent - the norm of previous decades - to about 6 to 7 percent over the next 10 years. The country's growth model is switching from an investment and export-oriented one to a more efficient model driven by both domestic consumption and investment. The stimulus package initiated by the central government in response to the financial crisis of 2008 has had a lot of side effects, including overcapacity in manufacturing industry, soaring local debts and real estate bubbles in several cities. Each problem is monumental. Tackling them altogether is the ultimate challenge.

China has to address these daunting issues in a slumping global economy that is showing signs of stagnation. There are also the regional political conflicts around the world, the looming interest rate rises by the United States Federal Reserve - which will have a negative impact on emerging economies - and the widening gap in growth rates between developed and developing countries. Chinese exports face a bleak global market and a short-term influx and outflow of capital. These uncertainties have made China's domestic economic problems more difficult.

We can understand the need for a new normal phase given that increasing labor costs, an aging population and falling savings deposits are creating a slowdown in the economy. Moreover, rising costs in production materials are hampering China's advantage as the world's factory, leading to an unsustainable export-oriented model. Overcapacity in manufacturing, the insufficient use of new infrastructure built in the middle and western areas of China, and an oversupply of real estate properties in some cities will hinder the return of investment in traditional industries. Complicating matters, the State-owned enterprises' monopolies of the service industry are in effect preventing the infusion of private capital. Essentially what we are seeing is that traditional industries are not digesting investment while emerging sectors are suffering from a severe shortage of credit.

Another new phenomenon in the Chinese economy is the emerging threat of financial risks. In recent decades the central government has intentionally curbed the financial sector to maintain investment-driven growth.

It deliberately lowered capital prices to channel that capital from the civic sector to the corporate sector and the government. The economy was mostly driven by fixed-asset investments. But that strategy is rearing its ugly head. Currently, corporate debt accounts for more than 130 percent of the country's GDP, with the banking sector depending too greatly on real estate.

The loose financial and monetary policy has pushed up local debts, which appear on the cusp of default. As China pushes further with interest rate marketization and the opening of capital accounts, these potential risks will gradually reveal themselves. In the next few years, commercial banks may see more non-performing loans, shadow banking defaults and possibly bankruptcies. If precautions are not taken, regional and even systemic financial crises will threaten China's economy.

A structural adjustment is an imperative for the Chinese government in the new normal. Efforts need to be made to create a nationwide balance in the distribution of income among the public, corporations and the government. The SOE monopoly of highly profitable service industries must be broken. Interest and yuan exchange rates must be further marketized. But vested interests will not let go of the obsolete export-oriented growth model without a fight. It needs courage and wisdom for the new leadership to push forward reform against all odds.

Lastly, the government is unlikely to repeat an implementation of loose, across-the-board macro-economic policies. The government overreacted during the financial crisis of 2008, and the consequences of the 4-trillion-yuan stimulus package and the surge in banking credit in the wake of the crisis - which included industrial overcapacity, soaring local debt and real estate bubbles in some cities - continue to challenge the stability in the country's economy. If this policy continues, it will lead to more severe inflation and capital price bubbles. Instead of managing the economy at the macro level, the central government can be more effective if it scales down its adjustments, simplifies administrative approval procedures, gives more freedom to small and micro businesses and allows more independence to the central bank.

This year the government is expected to focus on the financial industry, including the introduction of a national deposit insurance company and a marketization of interest rates. It is also experimenting with joint-ownership of SOEs through the use of private shares.

The fiscal and monetary policy will be further loosened and the deficit will increase in its proportion to GDP this year. With the annual economic growth rate estimated at 7 percent this year, if a slowdown escalates, it may not leave much room for structural reform. Consequently, fiscal spending is expected to rise and the proportion of fiscal deficit to GDP is going to rise. Interest rates will also fall further.

Financial risk control is likely to top the central government's agenda. It may legalize some shadow banking businesses or allow defaults to occur in some financial institutions. On the other hand, it will keep emerging risks under control. Introducing deposit insurance companies is one way of keeping risks at bay.

The Chinese government is expected to be more prudent in opening capital accounts. The sudden depreciation of the rouble serves as a warning for the Chinese government that if the government loosens its grip on capital accounts, it can only rely on rises in the interest rate once capital quickly flows out of the country. That in turn will have a lot of side effects. Capital account management is a tool that the Chinese government cannot afford to lose in the context of an unstable global economy.

The author is a senior research fellow at the Chinese Academy of Social Sciences. The views do not necessarily reflect those of China Daily.

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