China, the world's economic powerhouse, is grappling with a slowdown. While the nation faces undeniable challenges – a shrinking workforce and a mountain of debt – many analysts believe Beijing's rigid policy choices are exacerbating the situation.
Premier Li Qiang's recent address to the National People's Congress (NPC), his first in his new role, offered little reassurance. The annual parliamentary session outlined growth targets of "around" 5%, inflation of 3%, and 12 million new urban jobs – figures increasingly disconnected from reality.
China's economic potential, the rate at which it could grow with ideal policies, remains unclear. While fiscal constraints exist, particularly due to profligate local governments, the potential for growth is demonstrably declining as the working-age population shrinks.
The fear of repeating past stimulus mistakes seems to be driving Beijing's current approach. However, this excessive caution risks mirroring the post-2009 Western error of keeping monetary and fiscal policy overly tight, leading to stagnation.
Despite economic weakness, China's short-term interest rates and government bond yields remain stubbornly high, mirroring levels seen during the 2016 downturn. This may not significantly impact the housing market, currently plagued by developer insolvency fears, but it undeniably restricts borrowing in other sectors.
Independent estimates suggest China's real interest rates have significantly exceeded the "neutral rate" needed for full employment and stable inflation since late 2021. Economists propose a reduction of nearly a full percentage point to rectify this.
High-frequency employment data from Purchasing Managers Indexes (PMIs) paint a bleak picture. Research firm Gavekal reveals that a weighted index of China's employment PMIs, reflecting job market trends across various sectors, has been significantly below its long-term average for most of 2023, with the services sector experiencing the most significant drag.
Considering the continued restrictive monetary policy and near-zero inflation, a 3% inflation target and a growth target matching last year's are simply unrealistic. Additionally, the fiscal policy outlook offers little comfort. The budgeted state deficit stands at 3% of GDP, with planned special treasury bond issuance pushing this figure to 3.8% – identical to 2023.
True fiscal spending often occurs off-budget through local governments and state-owned banks. However, lower interest rates are crucial for facilitating such financing, especially if Beijing wants to avoid hindering already sluggish private investment. While Premier Li hinted at some flexibility on rates by suggesting money supply growth should align with growth and inflation targets (a subtle shift from last year's focus on nominal growth), he also emphasized exchange rate stability and avoided mentioning "flood-type" stimulus in his speech.
The speech's glaring omission of the struggling services sector is concerning. Mentions of "services" were limited to just four instances, with one focusing on integrating services with manufacturing. Conversely, "striving to modernize the industrial system" was highlighted as a primary task for 2024.
While Premier Li did hint at potential government incentives for consumer spending, through "trade-in" programs, Beijing seemingly clings to the outdated strategy of manufacturing and exporting its way out of trouble. This approach ignores rising global protectionism and the immense potential for a strong rebound in the services sector with the right policy support.
