Can China walk the reform talk?

Beijing has demonstrated its ability to manage difficult economic challenges and still deliver sustainable growth, but the pressure for deeper structural reforms in 2014 is growing.

China’s 2013 full-year economic growth data confirm what has been apparent for some time: China’s economy has settled into a high, but sustainable growth path. Putting aside excited commentary about two or three basis points movements in growth – and straw-men comparisons of this sustainable period of growth with the unsustainable, double-digit growth of the recent past – China’s rate of economic growth is largely unchanged in two years. And it is a rate of growth that would double GDP every decade.

In 2013, GDP increased by 7.7 per cent over the previous year, about the same as in 2012. Industrial production grew strongly, increasing 9.7 per cent year-on-year; retail sales were up 13.1 per cent on the previous year; and investment in non-rural fixed assets was up 19.6 per cent. Not surprisingly, business confidence remains robust, with a key indicator showing confidence on the index at 119.5 – anything about 100 is buoyant.

Increasingly negative sentiment about China’s economic prospects has been gathering, especially connected to concerns over local government debt and rapidly rising debt levels in the informal, or ‘shadow’, banking sector. Fears have been compounded by a series of short-term liquidity squeezes, leading to steep spikes in the overnight inter-bank settlement rates on at least four occasions in the past six months.

The People’s Bank of China is evidently caught in a delicate balancing act between tightening liquidity and introducing stricter, market-oriented disciplines across the financial sector, on the one hand, and ensuring that there is sufficient liquidity in the system to sustain what are by international standards high rates of economic growth, on the other.

Both narrow and broad measures of money supply, M1 and M2 respectively, grew somewhat faster in 2013 than real economic activity: M1 (cash) rose 9.3 per cent and M2 (cash plus deposits) increased 13.7 per cent, but China’s inflation rate remained stable at around 3.5 per cent.

Despite years of efforts by the central government to slow rising property prices in China’s first tier cities, however, these continued to grow apace in 2013. New house prices in major cities rose 27 per cent in 2013 compared with 2012.

Although the reliability of all these data is questionable when used for short-term analysis, and none more so than measures of inequality, the government is claiming that China’s income distribution is becoming more equal after years of growing inequality.

The National Bureau of Statistics is claiming that China’s Gini-coefficient (a measure of inequality) fell once more in 2013, making it the fifth successive year of improving income distribution. At the same time, the rural-urban gap also narrowed, with urban real disposable incomes rising 9.6 per cent compared with rural incomes which rose 12.4 per cent, compared with 2012.

On the external front, in 2013, China’s exports were up 7.9 per cent over 2012 and imports were up 7.3 per cent. Growth in imports was broadly in line with overall growth in the economy. 

The export performance is noteworthy. China’s currency, the RMB, has been appreciating in both nominal and real terms against most other currencies, while at the same time, strong cost pressures, especially high labour and raw material costs squeeze business margins. China’s continued strong export performance, especially when the world economy remains so sluggish, suggests strongly that China’s manufacturers are making considerable progress in moving up the value-added chain. This has been little commented upon as analysts pore over the recent economic data releases.

All in all, the Chinese government should be well pleased with both its economic management in 2013 and the way the economy performed. It continues to manage to sustain growth while trying to sort out some major structural challenges, such as the heavy reliance on fixed capital formation – especially infrastructure investment – and to renovate the financial system to serve better the bigger, more complex and decentralised economy that China has become.

The challenges facing China’s economic managers in 2014 are well known. Among the most pressing is how to unwind the rapid buildup of debt at the municipal and provincial levels and in the shadow-banking sector. While some of the numbers look scary, the problems are not insurmountable. Importantly, the government and key policymakers and advisers are well aware of these. Official media discusses the issues and policy responses daily. China’s economy, for better or worse, remains largely what has been for many years: one in which the state continues to regulate economic activity through a mix of market and administrative means.

2013 was yet another year that further demonstrated the leadership’s capacity to manage its way through difficult economic challenges, while sustaining internationally high rates of growth.

The pressure for deeper structural reforms, however, is growing. 2014 might well prove to be a much harder year for the policy elite to manage, especially if a too rapid QE taper in the US triggers an unmanageable liquidity squeeze in China. But the leadership has a lot of firepower in its financial reserves and the formal banking system, and a lot of policy instruments at its disposal. Muddling through while maintaining high rates of growth, will still be in 2014 an impressive performance by the standards of most of the world’s major economies.