Another credit-driven investment splurge in China carries the risk of causing stagflation

  • If Chinese policymakers want to support the economy, they best avoid the use of credit-driven splurge in infrastructure investment.
  • If such a path is taken, ANZ Bank warns it could lead to a period of stagflation in the Chinese economy.
  • Given the current slowdown is structural, not cyclical, it says the best method to stimulate economic activity is to cut tax rates.

If Chinese policymakers want to bolster economic activity in the period ahead, they need to learn from mistakes made in the past, according to economists at ANZ Bank.

In particular, a credit-driven infrastructure splurge — akin to that used in the immediate aftermath of the global financial crisis — has created many of the problems the domestic economy is grappling with at present.

“Many of the economic and financial issues currently faced by China originated from the 4 trillion yuan stimulus package unleashed during the 2008-09 global financial crisis,” the bank says.

“This time round, however, the central government will want to avoid using the same old credit-push, investment-led growth model.”

ANZ says there’s a good reason why such stimulus measures should be avoided on this occasion: it carries the potential to create stagflation, a period of high inflation but sluggish economic growth.

“As China’s economic slowdown is structural rather than cyclical, stimulus may shore up sentiment but fail to lift growth potential,” it says.

“With supply-side constraints, counter-cyclical measures may risk bringing about stagflation and real investment return in the future.”

A structural change is one that is permanent, a scenario the Chinese economy is facing as growth slows from rapid levels seen in recent decades. In contrast, a cyclical slowdown is one that is temporary in nature.

This chart shows the relationship between Chinese producer price inflation and capacity utilisation rates throughout China’s industrial sectors. The lift in the latter reflects the shuttering of inefficient or obsolete capacity as part of Beijing’s plan to improve profitability levels and lessen environmental impacts.

ANZ Bank

Instead of a quick fix that risks creating even larger problems down the line, ANZ says tax cuts are the most palatable solution to help cushion the current downturn.

“Implementing a tax cut seems to be the most viable policy that will potentially deliver long term economic benefit,” it says.

“China’s personal and corporate tax rates plus other fees could be considered as one of the highest in the world.”

ANZ Bank

ANZ says a cut in corporate taxes, rather than a devaluation in the Chinese yuan, will help boost China’s international competitiveness, and make it an attractive places to do business.

“Instead of competitive currency devaluation, a competitive tax cut could improve economic efficiency and lift the country’s productivity on a long-lasting basis,” it says.

Ahead of China’s Q2 GDP report released in less than two weeks, it is forecasting a slowdown in the year-ended growth rate to 6.6%, down from 6.7% in June.

“Based on our sequential model, China’s PMI readings in the September quarter suggest GDP growth of 1.7% quarter-on-quarter, lower than 1.8% pace in Q2,” it says.

“If we use the same seasonal factor as Q3 2017, it will translate into 6.6% year-ended growth in Q3.”

Even without the use of a model, one suspects ANZ may be right, with risks tilted to the upside.

How so, you ask?

Well, the median economist forecast is looking for 6.6% growth, according to those offered to Thomson Reuters, and in each GDP report over the past three years, the actual growth has either meet or exceeded forecasts by 0.1 percentage points.

Given that somewhat miraculous statistic, a reading of 6.6% or 6.7% appears a near-certainty based on recent form.

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