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Why Did China Set Its 2012 Growth Target Lower At 7.5%?
Malaysia Perspective | 24 May 2012

By Yeoh Mei Kei

Premier Wen Jiabao announced at China’s 11th National People’s Congress (NPC) meeting that the nation’s gross domestic product (GDP) growth target will be adjusted downward from 8 to 7.5 percent for 2012. Even though this was the first downward adjustment after holding the GDP growth at 8 percent for seven years, we think the market’s initial reaction to the lower than 8 percent GDP growth was overplayed.

Expectations Management
Over the past 10 years, China has always been able to surpass its growth targets. As Chart 1 shows, the economy has successfully grown at a rate which exceeded the official target every year, even by a substantial level, such as that seen in 2007. In addition, the government typically adopts a rather conservative growth target, so that the growth target can be surpassed, and hence minimising the occurrences of negative surprises.

Chart 1: China Actual And Targeted GDP Growth

Having said that, the downward revision in GDP growth, to some extent, reflects the expectations that the Chinese economy is slowing down. China would not be immune from a weaker global economy growth, thus part of the underlying motivation to lower the growth target is to skillfully manage the markets’ expectations over the Chinese economy growth.

Quality, Not Quantity
Apart from managing expectations, a lower growth rate also indicates an important transformational year for China as the economy embarks on some major steps towards a consumption-driven economy. As outlined under the 12th Five Year Plan (FYP), the government now focuses on quality growth instead of quantity growth.

As Chart 2 shows, the Chinese economy has become increasingly reliant on investments as a major contributor to GDP growth over the past decade, while consumption’s contribution has been steadily declining. Over the past 10 years, investments’ contribution to the economy growth has increased from 36.5 (in 2001) to 48.6 percent (in 2010). In 2003, investments’ contribution started to exceed private consumption’s contribution. The rapid growth in investments over the years was largely motivated by the expansion in infrastructure development as part of the 11th FYP (which spanned from 2006 to 2010). The massive 4 trillion yuan post-financial crisis fiscal stimulus further boosted the rapid growth in investments as the stimulus package infamously caused over-capacity and over-investments across the nation. This led to a sudden spike in investments’ contribution between 2008 and 2009, the year in which investments’ contribution rose from 43.9 to 47.7 percent.

Chart 2: Contribution Of Private Consumption And Investments To GDP

A high level of investments is a typical feature of a high-growth emerging economy. But as China’s investments approach the 50 percent of GDP level, it raises the concern that whether the current level of investments growth is sustainable. Furthermore, heavily reliance on investments means that a minor shock in investments would have a substantial impact to the overall economy growth. This explains why the government has emphasised on pushing “quality” instead of “quantity” (i.e. large amounts of investments) growth drivers in order to transform Chinese economic growth model into a sustainable one.

The basic idea under the 12th FYP is to increase the population’s propensity to consume. The government aims to achieve this by expanding the services sector and value-added products to create jobs, raising minimum wages, and also to strengthen the social safety net so that the people will save less and spend more.

Another major way to increase consumption in China is through income redistribution via the Individual Income Tax system reform. The reform will provide relief for the low- and middle-income earners by increasing the lower taxable income bracket threshold, at the same time the tax burden for higher income earners will increase. Local Chinese employees earning below the Rmb19,000 threshold will benefit from this reform, increasing the low-to-middle income earners’ propensity to consume.

One of the obstacles the Chinese government has been facing when implementing the above mentioned goal is the inflationary pressures, which will inevitably weigh on consumer’s propensity to consume. As inflation seems to be under control, we believe that the pro-consumption goals will become easier to achieve. Also, it will give the government more space to increase minimum wages, something that should only be implemented when inflation is expected to be benign.

The transformation of the economy may put a slight drag on economic growth, especially at its early stages. This explains why we view the downward revision of growth target as a positive sign as it demonstrates that the government is going to stabilise the Chinese economy growth over the long run.

Unhealthy Competition Partially Subdued
One of the drawbacks of a high GDP growth target is that it promotes local governments to engage in aggressive tactics to “compete” in boosting its province’s own GDP growth rate. Last year, the GDP growth rate target for some provinces had been set far above the official 7 percent growth target. For example, some provinces such as Chongqing had set its target as high as 16.4 percent. In fact, some of the larger provinces as shown in Table 2 grew at an annual rate of over 10 percent in 2011.

This sort of unhealthy competition is the factor that induced local governments to borrow excessive amounts to invest into sub-optimal infrastructure projects after the financial crisis. These are the investment projects that have subsequently enlarged the potential risks of a spike in non-performing loans in China.

We believe that lowering the GDP growth target will ease the pressure on local governments, softening their desire to compete for unsustainable high economic growth that are generated from massive investment projects.

Implications For Investors
In conclusion, we believe that the lower GDP growth target merely reflects
i. The weakening external demand
ii. Management of growth expectations
iii. The probable results from the quality transformation in economic growth model

In fact, the implications of the downward revision along with the other topics addressed by the government during the NPC meetings assures us that the government will progress towards boosting domestic consumption and stabilising the Chinese economy going forward. We do not see the downward revision of growth target as a detriment to the long-term outlook of Chinese economy.

*Yeoh Mei Kei is a Research Analyst at

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