For Chinese policymakers, 2016 will be about maintaining a reasonably high rate of GDP growth, reforming and rebalancing the economy and ensuring financial and economic stability. However, against a backdrop of slowing economic growth, continued capital outflows and rising corporate stress, it will be increasingly difficult for these policy objectives to be achieved in unison.
That’s the view of Michael Taylor, Moody’s managing director and chief credit officer for Asia Pacific, who suggests that if there’s one area that will assume lesser importance to policymakers in the year ahead, it will likely be the government’s reform agenda.
“With the government having now given a strong commitment to a growth target of between 6.5%-7.0%, it seems unavoidable that one of the other policy objectives will assume lesser priority,” says Taylor. “The most likely near-term casualty is reform momentum.”
Here’s Moody’s on why it believes it will be difficult for China to implement two, let alone three, of the objectives specified by the government at the National People’s Conference last weekend.
If the authorities choose to prioritize reform while trying to maintain a growth target of in excess of 6.5%, the consequence will be to sacrifice some degree of financial stability, and accept a larger level of RMB depreciation, more widespread defaults, and perhaps even some failures in the banking system.
Alternatively, a combination of growth and stability is also achievable, at least for some time, but such a strategy will leave unaddressed the deep imbalances in China’s economy, such as elevated system leverage and excess capacity. The risk is that the support necessary to achieve 6.5% growth instead postpones the restructuring of the SOE sector by creating artificially favorable demand and maintaining accommodative financing conditions for loss-making, as well as viable SOEs.
A third combination would be to try to combine reform with financial stability, but allow growth to decelerate below current targets. This combination would involve the authorities eschewing fiscal or monetary stimulus to revive investment in the pursuit of growth targets, using their still substantial fiscal and reserves buffers to smooth currency and financial market volatility, and proceeding with policy reforms.
Essentially, the government will likely have to choose between a combination of market reform and economic growth, scuppering financial stability, keeping financial stability and maintaining economic growth, something that will push aside market reforms, or combining reform with financial stability, sacrificing economic growth.
Sacrificing economic growth appears unlikely, as does the acceptance of heightened levels of financial instability given mounting concerns about the nation’s mounting debt levels at present.
That leaves structural reforms as the one area the government may sacrifice in order to maintain robust levels of economic growth, and as a consequence social stability.
That wouldn’t be surprising if it were to occur – if there’s one thing markets have become accustomed to in recent years it’s hearing about the need for structural reforms without seeing many taking place. And of those that have occurred, such as those in financial markets, many have ground to a halt, or have been overridden, by government coercion as a result of market movements not being deemed appropriate by policymakers.
Make no mistake, reforming the nation’s vast state-owned enterprises (SOEs) will be a difficult task. Unemployment will likely rise as will the potential for corporate defaults.
However, the longer this unenviable task is left, the worse the situation will become.
Cheap liquidity, lower borrowing costs and state-backed infrastructure spending has kept many marginal firms afloat. While pulling the life support system on them can’t be done all at once, for 2016, the challenge for Chinese policymakers is to at least make a start.