No stimulus from Beijing, so what's next?

China bears will giggle today when Beijing releases its much-anticipated first quarter GDP figure for 2014. The market consensus is between 7.2 and 7.3 per cent growth rate and a notch below the official goal of 7.5 per cent.

Sluggish economic data since the beginning of the year has sparked wild speculation of a stimulus package, including an incredibly delusional rumour of a seven trillion yuan gangbuster deal from five provinces.

Chinese Premier Li Keqiang, who has a proper PhD in economics from Peking University, publicly poured cold water on such speculations not only once but twice in the last month. At the Boao Forum, he made it clear in his opening speech that China would not use stimulus measures to smooth out economic fluctuation.

“We will instead focus more on healthy development in medium to long term,” he said. At the recently concluded Chinese parliamentary gathering, Li also asked the rhetorical question “why can’t we do it again?” in response to a question about whether it was possible to repeat 2013’s performance without stimulus.

Beijing should be applauded for its principled stance against reckless stimulus policy. Li’s public statements are the clearest signals to date of the Chinese government’s departure of its once sacrosanct belief in GDPism.

It is also recognition of the economic reality. The country is still suffering from indigestion as a result of its sumptuous feast of the last four trillion yuan stimulus package. The worsening problems of local government debt, excessive capacity, shadow banking are all after-effects of Beijing’s stimulus. The appetite for another round is not really there; well, at least for the time being.

But don’t expect this debate to go away. And we will hear more noises in the future if the economic situation continues to slide. Is Beijing going to be principled in three months’ time when the downward trajectory is not showing sign of abating?

Beijing’s response so far seems to be two-pronged. The Chinese will accelerate targeted investment in certain areas such as railway infrastructure in remote areas. The number of projects has been increased from 44 to 48, while the total fixed asset investment will be lifted from 700 billion yuan to 720 billion yuan.

Investment plans from other provinces also show clear preferences for transport, renewable energy, water and environmental projects. These are quite different from the heavy industrial and real estate projects back in 2008.

But the most important solution and the most difficult to implement is the structural reform. In fact, China’s neighbour Japan is facing a similar challenge now as the government needs to implement the third arrow -- structural reform -- of Abenomics.

China has been talking about structural reform for the last decade and its rapid growth put that on the back-burner. When the modern economic history of China is written, the ten years under the Hu-Wen administration could only be described as the lost decade.

Now the clock is ticking. China has a narrow window of opportunity to set its house in order again before the confluence of problems become unmanageable.  It is an important point: debts, banks and housing sectors can all blow up quickly with little warning but reform dividends take time to realise.

Let’s have the good news first. The Chinese central bank is leading the charge to push through reforms like interest and exchange rate liberalisation. The central bank governor Zhou Xiaochuan promise full liberalisation of interest rates in two years and the rise of internet finance in China is accelerating that (Alibaba and the Chinese banking thieves, February 26).

Sinopec, one of the largest state-owned enterprises, is putting 300 billion yuan worth of assets on the auction block in China and it is open to both foreign and domestic investors. It is a good sign that Beijing is finally making a bit of progress on this issue.

But we have yet to see other major reform initiatives on shadow banking, allowing local governments to issue their own debts, managing local government financing vehicles, abolishing the household registration system, clarifying land ownership issues and the hardest of all, the reform of powerful state-owned giants.

Reform dividends could be huge. Analysts calculate that if state-owned enterprises can bring their level of efficiency and productivity to that of their private counterparts, China’s GDP could add another two per cent. That means an additional 11 trillion yuan or $1.9 trillion, which is larger than Australia’s GDP.

Even the Stalinist National Development and Reform Commission admits the country needs to embrace market-driven reforms to rejuvenate. So China knows what needs to be done and the big question is whether it has the political will to do it.

Ironically, Japanese Prime Minister Shinzo Abe is facing the same problem in Japan. So far all signs are not encouraging from Tokyo. So can the Chinese be more reform minded than the Japanese and win the race against the time to set their economy on a more sustainable path?

Only time will tell. There is a lot at the stake not only for China but Australia too. According to Capital Economics, Australia will be the second worst affected country in the world after Hong Kong if China suffers a hard landing.