Premier’s Robbins: Is China’s 6-7% growth target a fantasy?

Robbins Jake Premier Asset Management 2014

Chinese GDP growth targets for 2016 have recently been set at 6.5 to 7 per cent, compared with a target of “around 7 per cent” for 2015. As things turned out, the official growth rate for 2015 came in at 6.9 per cent, which was perfectly compatible with their stated target of around 7 per cent.

As such, it is probably fair to expect that the official growth rate this year in China will hit their minimum 6.5 per cent target at almost any cost rather than face having to cut their own target. This target would also be in line with the longer term stated goals of doubling Chinese income levels by 2020. Secondarily, their inflation target remains at 3 per cent, although like every other central bank these inflation targets haven’t been met for some time and are consistently pushed out further into the future.

Given how key Chinese GDP growth has become to both global growth and financial market stability, how plausible is their growth target? Or are we more likely to see continued Chinese economic data disappointments?

First, the government seems willing to continue to loosen monetary and fiscal conditions sufficiently to ensure growth. Having already cut rates six times since the end of 2014, not to mention loosening policies surrounding housing and autos amongst others, what else can they do to achieve growth?

With interest rates still at a relatively high 4.35 per cent, there is plenty of scope to cut these further. Loosening the bank reserve ratios also releases liquidity into the economy. Other targets include growth of 13 per cent in total social financing, essentially directing state-owned banks to continue to lend at rates well in excess of GDP growth. While this may continue to raise the country’s overall debt levels to even more uncomfortably high levels, it should support growth in the near term.

Second, a commitment to run a 3 per cent fiscal deficit is the highest in the country’s history and should ensure a stimulus through continued investment in infrastructure. Some of this deficit also comes in the form of tax cuts, a better way to enact supply side reforms and allow markets to allocate capital rather than the state.  

Another target that is very close to the government’s heart is to create 10m jobs and a maximum unemployment rate of 4.5 per cent. Clearly one of the biggest fears of the communist party is mass social unrest, and the best way to avoid this is delivering jobs and greater wealth to the masses. Urbanisation continues apace in China and policies are clearly aligned with this to continue.

On a much brighter note we have already seen monetary easing begin to push Chinese house prices higher and auto sales have remained robust. Services now make up over 50 per cent of Chinese GDP and have consistently outgrown the manufacturing sector. As one grows and the other is arguably shrinking then Chinese attempts to rebalance the economy to a more domestically-focused economy continue apace.

Unfortunately, on the other hand, there remain many negatives associated with their economy. There are no targets for trade levels this year other than a vague commitment to faster growth than 2015. Given exports fell around 3 per cent and imports by a whopping 14 per cent (largely due to the slump in energy and metal prices) then this maybe doesn’t appear too tricky. Having said that, even allowing for Chinese New Year, the most recent data points to a 25 per cent fall in exports in February while imports were down 14 per cent.

Deflation probably has a large part to play in this as the value of commodities are so much lower today than this time last year, but this is clearly not healthy. Excess capacity in Chinese manufacturing is a constant drag on growth and needs addressing sooner rather than later. Deflationary pressures are rippling around the world partly because of China’s massive over-investment in industries such as steel and aluminium. With corporate debt at dangerously high levels and largely owed by these loss-making industries, the Chinese government must proactively shut down any uncompetitive capacity and support the banks through the inevitable large losses.

Until this painful but necessary process is completed, Chinese manufacturing will remain a massive drag on both their own and global growth. Japan had the same issues and refused to do anything about it for decades, guaranteeing an environment of almost perpetual non-existent growth and deflation. Sadly, Europe seems also to be embarking on this route with their own refusal to acknowledge excess capacity and bad loan issues in many of their banks. Look at the Italian banks with non-performing loans as a percentage of the entire loan book in the mid-teens – given this is an economy that has struggled to grow at the best of times then this is a very worrying state of affairs and needs dealing with.

Fortunately the Chinese government has crucially acknowledged the need to reduce overcapacity and reform their state-owned enterprises, the areas where almost all of China’s woes reside. Whether they actually follow through with this promise or not, only time will tell. What we do know, however, is that without the political will to do something about it, the current economic environment may well be here to stay.