Mon, Feb 11, 2019 - Page 7 News List

China’s difficult balancing act

By Gene Frieda

After a long period of investment-driven growth, China is finally changing its policy playbook. Having recognized the costs of relying on excessive credit growth in the medium term, now it is emphasizing tax cuts, further market opening, and incentives to boost consumption over investment. This means accepting lower growth rates in the future.

Yet, seven months into this shift, it is clear that these new policy measures alone will not be enough to stabilize growth at a sufficiently high rate. The targeted nature of the fiscal stimulus announced so far, together with regulatory efforts to limit the adverse side effects of earlier policy easing, suggest that the stabilization process will be longer and more arduous than expected.

There will be strong temptations to return to the old model as the economy adapts, but China’s leaders seem to accept that unless there are major negative shocks, they should not open the credit floodgates again to address cyclical weakness.

As a result, China must perform a difficult balancing act. It needs to keep growth high enough to maintain social stability, while also maintaining external stability, as reflected in the renminbi’s exchange rate. How China manages its currency during the policy shift could have important global consequences.

Other Asian economies faced a similar problem two decades ago. A central lesson from the 1997-1998 Asian crisis was that rigid exchange rates were incompatible with rapid, debt-driven growth.

Fueled by cheap debt, fast-growing Asian economies tried to maintain high investment rates for far too long. Their current accounts deteriorated, and growth slowed as their currencies remained pegged to a sharply appreciating dollar. Eventually they were forced to devalue their currencies as capital fled and foreign reserves dwindled.

In the wake of the global financial crisis, China managed to maintain high rates of investment growth only through rapid credit expansion. As a result, aggregate debt levels surged to around 270 percent of GDP last year from approximately 150 percent in 2008. Over the same period, China’s current-account surplus fell from 9 percent of GDP to less than 1 percent.

Because these high debt levels limit China’s policy options, the renminbi’s exchange rate could play a more important role in stabilizing growth than in the past, but the perceived political constraint on depreciating the currency to support growth, and the increasing role of the state sector in the economy, are adding to cyclical headwinds and making stabilization more difficult.

There are also uncertainties regarding China’s future growth model, stemming from Western challenges to Chinese participation in the global trading system and the inconsistencies between the old and new policy playbooks.

These uncertainties, in turn, create negative feedback loops. Risk-averse lenders shun private-sector borrowers because of a lack of good collateral and the implicit guarantees on loans to the state sector.

The role of the state naturally strengthens as the government tries to stabilize growth rates at lower levels.

A lack of alternative financial assets channels savings into the property market, but high-real estate prices force consumers to borrow more to buy property, crowding out consumption. And the bias toward infrastructure investment limits investment in services spending on education, healthcare, and financial inclusion, preventing the economy from producing what consumers want.

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