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Li’s Options Narrow As China Slowdown Threatens Target
Perspective | 18 September 2014

Chinese Premier Li Keqiang’s options have narrowed: stimulate or miss his 2014 growth target.

The weakest industrial-output expansion since the global financial crisis, and moderating investment and retail sales growth shown in data released on 13 September, underscore the risks of a deepening economic slowdown led by a slumping property market. Stocks, metals and currencies including the Australian dollar fell as analysts cut their forecasts for 2014 growth.

“This is a pretty important wakeup call that they need to do more,” said Helen Qiao, chief Greater China economist at Morgan Stanley in Hong Kong. “The government is trying very hard to reach this particular target rate, which will not necessarily be mission impossible if they roll out more easing measures starting from now. The risk is they could underestimate how much more easing tools they need.”

The slowdown in August economic data that included a second straight decline in imports and a 40 percent drop in the broadest measure of new credit will test Li’s resolve to avoid stronger monetary stimulus to meet his 7.5 percent goal. An unprecedented lending spree from 2009 to 2013 led to a surge in debt on a scale that has triggered banking crises in other economies, according to the International Monetary Fund, underscoring the premier’s reluctance to open the spigot.

Growth in gross domestic product (GDP) may slip to 6.5 percent to 7 percent in the third quarter if September numbers are also weak, Australia & New Zealand Banking Group (ANZ) analysts estimate, down from 7.5 percent in the April to June period. A monthly GDP tracker compiled by Bloomberg shows the economy expanding 6.3 percent in August from a year earlier, down from 7.4 percent in July.

Forecast Cut
Royal Bank of Scotland Group (RBS) cut its forecast for China’s 2014 economic growth to 7.2 percent from 7.6 percent, citing weak momentum indicated by the August data.

“We still expect the government to step up the rollout of measures to support growth, such as boosting infrastructure and other investment, relaxing property market policies and taking more monetary easing steps,” said Louis Kuijs, chief Greater China economist at RBS in Hong Kong.

Barclays lowered its projection for 2014’s GDP expansion to 7.2 percent, from 7.4 percent.

China’s interest-rate swaps dropped by the most in almost three weeks and stock gauges including the MSCI Asia Pacific excluding Japan Index, the Shanghai Composite Index and the Hang Seng China Enterprises Index all fell. Australia’s dollar weakened to a five-month low and the Chinese Yuan dropped, while copper led most industrial metals lower and oil prices declined.

Negative Spiral
“Li should be worried if he’s serious about meeting his 7.5 percent target,” said Liu Li-Gang, chief Greater China economist at ANZ in Hong Kong. “There’s a risk the economy could decelerate faster than he can tolerate and that would mean non-performing loans would rise further and we could get into a negative spiral for the economy where banks continue to cut lending, deflation will appear and growth will fall further.”

Industrial output rose 6.9 percent from a year earlier in August, the statistics bureau said on 13 September, down from 9 percent in July and the slowest pace outside the Lunar New Year holiday period of January and February since December 2008, based on previously reported figures compiled by Bloomberg.

Electricity output fell 2.2 percent, the first decline since May 2009 excluding January and February data. Growth in fixed-asset investment from January to August slipped to 16.5 percent while the drop in sales of residential housing by floor space deepened to 10 percent after a 9.4 percent decline in the first seven months.

Significant Deceleration
A central bank report last week showed aggregate financing fell to Rmb957.4 billion (US$156 billion) in August from Rmb1.6 trillion a year earlier. The producer-price index has been negative for 30 consecutive months and consumer inflation has not exceeded 2.5 percent since November.

“The data made it pretty clear that this deceleration is significant and they need to stop it from decelerating further,” said Song Yu, a Beijing-based economist with Goldman Sachs Group. “The bottom line is they need to maintain some kind of growth stability while pushing for reform.”

The likelihood of further monetary easing such as cuts in interest rates or banks’ reserve-ratio requirements has increased significantly, although they will probably be targeted rather than across-the-board moves to avoid giving the impression of cyclical policy stimulus, he said.

Government Spending
While Premier Li said on 9 September that the government cannot rely on monetary stimulus to spur economic growth, he has few other options. Stronger fiscal support is constrained by moderating tax-revenue gains, continuing reform efforts and the need for approval from the legislature to widen the budget deficit.

Central government spending in August rose only 1.6 percent from a year earlier after an 11.7 percent jump in July, a slowdown the Finance Ministry attributed to disbursements being made ahead of schedule in previous months. Growth in local authorities’ expenditure slid to 7.1 percent from 9.3 percent.

In a speech at the World Economic Forum in the Northern Chinese city of Tianjin last week, Li said the government would not be distracted by short-term fluctuations in individual economic indicators and will maintain its focus on structural adjustments and dealing with long-term issues.

Growth slightly higher or lower than the 2014 target of 7.5 percent is acceptable as long as employment, incomes and environmental protection improve, he said.

Tempering Expectations
Kevin Lai, senior economist with Daiwa Capital Markets in Hong Kong, said the market has underestimated the resolve of the new leadership in letting the economy slow down.

“The market has got a bit excited about policy stimulus and the government wants to temper those expectations and also reinforce the message about reform,” he said.

The struggle to meet this year’s target means Li will probably cut the goal next year to 7 percent, according to Goldman’s Song, ANZ’s Liu and Daiwa’s Lai. Morgan Stanley’s Qiao says a range of 7 percent to 7.5 percent is also possible.

“They don’t need 8 percent to 9 percent anymore,” said Lai. “If you remove the layer of growth related to things like corruption, overcapacity, the real-estate bubble, GDP growth would probably be about 5 percent.”

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