China’s Narrowing Policy Horizons

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Back in the last quarter of 2011, when the decline inChina’s investment growth accelerated, concerns about a hard economic landingintensified, particularly given the authorities’ reluctance to pursue newexpansionary policies. By May 2012, however, the government had changed itsmind, with the National Development and Reform Commission approving ¥7 trillion($1.3 trillion) in new projects. That, together with two ensuing interest-rate cuts by the People’s Bank ofChina (PBOC), guaranteed an end to the economic slowdown in the third quarterof 2012.
The Chinese economy’s performance has thus maintained thecyclical pattern familiar from the past two decades: rapid investment growth,supported by expansionary policy, drives up the economic-growth rate. Inflation follows, so policy is tightened and growthslows. But inflation remains high or rising, so more tightening is imposed.Inflation falls at last, but growth slows more than desired, owing to theovercapacity that resulted from excessive investment in the earlier phase ofthe cycle. At this point, policy becomes expansionary again, and the cyclebegins anew: led by investment growth, the economy rebounds.
Thus, the acceleration of economic growth since the thirdquarter of 2012 should come as no surprise. With the government still havingroom to wield expansionary monetary and/orfiscal policy, the economic revival was only a matter of time.
There is no reason to doubt that the Chinese economy in2013 will follow the old growth pattern. But China’s decision-makers should bear two things in mind. First, in the past,short-term macroeconomic stability was often achieved at the expense of structural adjustment and rationalallocation of resources. To achieve sustained growth, a balance between short-termand long-term objectives must be struck. Striking that balance is the biggest challenge facingChina.
Second, some financial vulnerabilities are embedded in theeconomy. Unless they are defused in time,financial shocks may derail the economy from itsnormal growth path.
According to preliminary reports, annual investment growthin 2012 reached roughly 14% – significantly higher than the GDP growth rate,which accelerated in the fourth quarter as a result of a strong rebound ininvestment in real estate and infrastructure. In 2013, it can be expected that,barring major disruptions, strong investmentgrowth will push China’s GDP more than 8% higher year on year.
The timing of the inevitable policy shift back totightening depends on overall inflation,particularly house prices. The problem is that the investment share of China’sGDP is already about 50%, while double-digit investment growth in 2013 isexpected to push that rate still higher. Such a growth path is simply notsustainable.
The money supply has grown significantly faster than outputfor decades. In 2012, the growth rate of M2 was about 14%, relatively low byhistorical standards, but still significantly higher than the nominal GDPgrowth rate. As a result of this chronicallyrapid growth in broad money, China’s M2/GDP ratio has surpassed 180%, thehighest in the world. Though the full implications of this uniquely high ratiofor macroeconomic stability need further investigation, it certainly impliesfinancial fragility and a weakening of thePBOC’s ability to control overall liquidity in the economy.
Third, though China’s public debt/GDP ratio is officiallystill under 20%, since the onset of the global financialcrisis in 2008, its fiscal position has deteriorated. If the government’s contingent liabilities are included, China’s debt/GDPratio may be closer to 50%.
A worrying development in this regard is the rapid rise inenterprise debt, which, according to various studies, now surpasses 120% of GDP– much higher than the leveraging rates of nonfinancial enterprises in major developedcountries. Even if this does not trigger a crisis, it sharply narrows thegovernment’s scope for using expansionary fiscal policy to stimulate theeconomy.
In 2011 and early 2012, there was much talk of a crash inChina’s housing market, and a chain-reaction of defaultsin underground credit networks andlocal-government finance platforms. In 2013, the talk has changed to the dangerof a resurgent housing bubble and the collapseof the shadow banking system, which consistsmainly of wealth-management firms and trust companies.
According to market sources, total assets managed by the shadow banking system have risen exponentially since 2009, totaling ¥14 trillion, orone-third of GDP, in the third quarter of 2012. With relatively slow growth, corporateprofitability, upon which the returns of the shadow banking system’s assetpools are based, is low and falling. Where, then, will the high returns of thefinancial products provided by the shadow banking system come from?
If the shadow banking system collapses, the consequencesfor the financial system will be much graverthan the problems caused by underground credit networks and local-governmentfinance platforms, which were much discussed in 2012. No wonder, then, that oneinfluential banker regarded as a possible successor to PBOC Governor ZhouXiaochuan has warned of the possibility of a “Chinese-stylesubprime crisis.”
For now, the Chinese economy, having received its cyclicaldoes of stimulus, should be okay. By the end of the year, however, the costs ofthe structural adjustment needed to shift China’s growth model away frominvestment demand could rise further.

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关键词：Horizons Horizon Narrow Policy arrow government investment economic together however

The Chinese economy’s performance has thus maintained thecyclical pattern familiar from the past two decades: rapid investment growth,supported by expansionary policy, drives up the economic-growth rate. Inflation follows, so policy is tightened and growthslows. But inflation remains high or rising, so more tightening is imposed.Inflation falls at last, but growth slows more than desired, owing to theovercapacity that resulted from excessive investment in the earlier phase ofthe cycle. At this point, policy becomes expansionary again, and the cyclebegins anew: led by investment growth, the economy rebounds.

There is no reason to doubt that the Chinese economyin 2013 will follow the old growth pattern. But China’s decision-makers should bear two things in mind. First, in the past,short-term macroeconomic stability was often achieved at the expense of structural adjustment and rationalallocation of resources. To achieve sustained growth, a balance between short-termand long-term objectives must be struck. Striking that balance is the biggest challenge facingChina.Second, some financial vulnerabilities are embedded inthe economy. Unless they are defused in time,financial shocks may derail the economy from itsnormal growth path.







The problem is that the investment share of China’sGDP is already about 50%, while double-digit investment growth in 2013 isexpected to push that rate still higher. Such a growth path is simply notsustainable.


The money supply has grown significantly faster thanoutput for decades.China’s M2/GDP ratio has surpassed 180%, the highestin the world.




though China’s public debt/GDP ratio is officiallystill under 20%, since the onset of the global financialcrisis in 2008, its fiscal position has deteriorated. If the government’s contingent liabilities are included, China’s debt/GDPratio may be closer to 50%.A worrying development in this regard is the rapidrise in enterprise debt, which, according to various studies, now surpasses120% of GDP – much higher than the leveraging rates of nonfinancial enterprisesin major developed countries.



According to market sources, total assets managed bythe shadow banking system have risen exponentially since 2009, totaling ¥14 trillion, orone-third of GDP, in the third quarter of 2012. With relatively slow growth, corporateprofitability, upon which the returns of the shadow banking system’s assetpools are based, is low and falling. Where, then, will the high returns of thefinancial products provided by the shadow banking system come from?


No wonder, then, that one influential banker regardedas a possible successor to PBOC Governor Zhou Xiaochuan has warned of thepossibility of a “Chinese-style subprime crisis.”