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China's lower growth targets – good news or bad?

13-03-2012 13:21

The stock markets reacted very negatively to the news that China is revising down its growth targets, something the country had flagged its intentions to do much earlier and which therefore should not have been news.

At a point when the economy is in two minds, signals pointing to weaker Chinese growth are bound to cause concern. At the same time, it can be worth reminding ourselves of the reasons why China is downsizing its growth targets.

The idea is that domestic demand should be allowed to become stronger. The fact is, private consumption is low in relation to the size of the economy today. And conversely, investment is high (around 50% of GDP) compared to other developing countries. The economy is basically export driven, which means as a country China is sensitive to the economic downturn in much of the rest of the world.

When the financial crisis and global recession began in autumn 2008, China was forced to modify its previous growth targets in order to create stronger domestic demand, and reduce the importance of its export sector. Which put the entire economy at risk. Renewed emphasis was therefore placed on the export sector. The country's growth touched 12%. This growth was helped by an economic stimulus package that boosted demand.

In 2007, China's Prime Minister Wen Jiabao called the Chinese economy unstable, unbalanced, uncoordinated and unsustainable. He was referring to the differences between urban and rural areas, the coast and inland, rich and poor, environment issues and not least, the growth in inflation. These same problems are still there in 2012. Once again, Wen Jiabao is arguing that the country's growth targets have to be reduced to ensure more sustainable growth.

In other words, this should not have been a surprise to the financial markets. That the stock markets are falling because growth can tail off if the government succeeds, something they have not previously been able to achieve, is surprising, especially given the fact that we are talking of a reduction in growth from around 8.5% to 7.5%. Of course there are companies that can be affected in other parts of the world, and Chinese banks will also feel the effects of a lower rate of growth. However, it is by no means certain that the country will succeed in dampening growth.

China needs to successfully manage the move from strong growth to weaker growth, and achieve this with a soft rather than a hard landing. This is a big challenge, not least because strong growth is the only thing that gives legitimacy to the country's political leaders. Having said that, 7.5% growth is still sufficiently high to prevent the political elite being fired, i. e. avoiding a people's revolt. Were growth to fall below 5% and inflation reignite, the risk of such a revolt would be more substantial.

For the global economy, for the goal of reducing economic and climate related imbalances in the world economy, the Chinese goal is welcome news. There is still plenty to be done if the rate of growth is to be reduced to the desired level. Rapidly plummeting property prices would probably put municipalities and regions at risk of going to the wall. Constructing a soft landing for property markets remains on the to do list.

In the short-term, growth, inflation and the property market are major risk factors. In the slightly longer term, I would prefer us to focus on liberalising the financial sector. How that should be done without China experiencing a bubble that eventually bursts like other countries that have made the transformation from a closed to an open economy. The Chinese currency, the Renminbi, will be able to be traded around the world. Creating a fully traded currency on the world market is a challenge. The Chinese administration probably also feel this will be difficult, which is why they are wary of moving forward too quickly. The domestic economy and financial sector need to be liberated first, and then be opened up in a way that does not jeopardise economic stability. China needs all the good luck messages the country can get – few other countries have managed to avoid bubbles and failings when they have gone through liberalisation – even Sweden and the Baltic countries cannot be used as successful examples. It is not just the Chinese economy that is at risk if the country does not succeed, the global economy would also be in danger. Even though tougher regulation has improved stability in the western world, the next financial crisis could be triggered by China – hold onto your hats!

 

 

Economists

Cecilia Hermansson
Cecilia Hermansson
Group Chief Economist, Economic Research Department, Sweden

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