China’s overambitious growth target will exacerbate many of the country’s economic problems. The looser monetary and fiscal policy necessary to reach this goal will put depreciation pressure on the renminbi, inflate asset prices and increase China’s debt burden.
China’s economic planners are aiming high: The goal in the 13th Five-Year Plan is to turn China into a “moderately prosperous society”, to double 2010 per-capita in-
come by 2020 and to eliminate poverty over the course of the next five years. To achieve these ambitious goals, average annual GDP growth is supposed to reach at least 6.5 percent. This target is not only unrealistic, but it threatens China’s economic stability due to its implications for both monetary and fiscal policy.
If economic policy-makers want to fulfil the expectations created by the plan, they will have to loosen both monetary and fiscal policy. This would exacerbate many eco-
nomic problems that have haunted China in recent years. A further loosening of monetary policy would increase depreciation pressures on the renminbi and lead to another surge in capital outflows, which the government recently tried so hard to contain. This would force the People’s Bank of China to continue its depletion of the country’s foreign exchange reserves in an effort to restore financial stability.
Since this is a highly likely scenario, it is not reassuring that the new five-year plan fails to provide any clues on how the government intends to deal with these challeng-
es. A dangerous real estate bubble is around the corner Asset price inflation would likely be another side effect of a looser monetary policy. As it will probably take China’s stock markets some time to recover from the turbulences of recent months, speculative funds are mainly set to pour into the housing market.
Given this market’s crucial role within China’s economy, the bursting of a real estate bubble could wreak great economic havoc. Home sales in the first-tier cities of Beijing, Shanghai, Guangzhou and Shenzhen already picked up substantially last year, and Shenzhen in February saw average prices per square meter rise by about 50 percent compared to a year earlier. With a further relaxation of monetary policy, there is no doubt that this trend will continue.
Moreover, a looser monetary policy would intensify China’s serious debt problem – another issue on which the new five-year plan has surprisingly little to say. China’s debt-to-GDP ratio is approaching 300 percent, and debt continues to build up despite the slowdown in economic growth. The most concrete measure the plan con-
tains to address this problem is a “broadening of the channels through which the banking industry can dispose of bad assets”.
During the closing session of the recent National People’s Congress, Shang Fulin, chairman of the China Banking Regulatory Commission, shed some light on what this might mean: Shang explained that the government was considering debt-forequity swaps to reduce the corporate debt burden. These swaps would allow commercial banks to convert the nonperforming loans in their books into stock holdings. With the slowdown in growth and the excessive leverage of many state-owned compa-
nies, nonperforming loans rose by 51 percent in 2015 to 1.27 trillion CNY according to official figures, though the true figure is probably much higher.
The Chinese business magazine Caixin recently reported that as much as one trillion CNY of these troubled loans might be swapped over the next three years.
While this might be good news for China’s heavily indebted state-owned enterprises, it would further undermine the financial health of the banks and thus fail to restore stability in China’s financial system.
A looser fiscal policy would likewise contribute to China’s growing indebtedness. Infrastructure investment will remain a focus of fiscal spending, and the new plan is not short on ambitious targets: at least 50 new airports for civil use will be built over the next five years, as well as 11,000 additional kilometres of high-speed rail tracks and 30,000 additional kilometres of super highways. Moreover, Beijing intends to create the world’s longest rail tunnel to connect China with Taiwan, which is schedul-
ed for completion by 2030.
At least this time around local governments will not have to bear the majority of the costs of the infrastructure spending spree. When it comes to the funding of stimulus measures, the central government finally seems to be willing to resume more responsibility, a trend that already became visible in 2015 and that was recently confirmed by Finance Minister Lou Jiwei at a press conference during the NPC. This is certainly good news for China’s chronically underfunded local governments, yet it fails to solve their financial problems.
Local governments have not only suffered heavily from falling revenues from the sale of land use rights. Their budgets have also been squeezed due to the transforma-
tion of business tax (that flows into the coffers of local governments) into value-added tax (that mainly flows into the central government’s coffers). To put local govern-
ment finances on a firmer footing and put an end to murky financing arrangements on the local level, Beijing needs to finally live up to its promise to redistribute fiscal resources between different levels of government – a reform that was already announced at the Third Plenum of the CCP’s Central Committee in 2013.
The new Five-Year Plan reiterates this goal and hints at a change in the distribution of value added tax revenue between central and local levels of governments as a possible remedy, yet it does not create the impression that tax reforms are set to significantly accelerate. For this reason, an increase in the central government’s debt burden will probably fail to prevent a further debt built-up at the local level.
A growing debt burden, a looming real estate bubble and rising capital outflows would turn the new five-year plan period into a bumpy ride. In their attempts to reach an overly ambitious growth target, China’s policy-makers might have to put urgently needed structural reforms on hold. Instead of creating a moderately prosperous society, Beijing thus runs the risk of pushing the country into the middleincome trap.
- Average annual GDP growth of at least 6.5 percent
- Average annual labour productivity growth of at least 6.6 percent
- Urbanisation rate of 60 percent
- Increase of the service sector’s share of GDP to 56 percent
- Increase of spending on research and development to 2.5 percent of GDP
- Increase of household broadband internet coverage to 70 percent
- Average annual growth of disposable per-capita income of at least 6.5 percent
- Creation of at least 50 million new jobs
- Lifting 55.75 million people out of poverty
- Increase of public basic pension coverage to 90 percent
- Reduction of CO2 intensity by 18 percent
- Good urban air quality on at least 80 percent of all days