China’s Boom Is Over—Beijing Is Making It Worse

Xi Jinping, China's president, left, speaks with Li Qiang, China's premier, right, during the opening of the Second Session of the 14th National People's Congress (NPC) at the Great Hall of the People in Beijing, China, on Tuesday, March 5, 2024. Bloomberg (Bloomberg)
Xi Jinping, China's president, left, speaks with Li Qiang, China's premier, right, during the opening of the Second Session of the 14th National People's Congress (NPC) at the Great Hall of the People in Beijing, China, on Tuesday, March 5, 2024. Bloomberg (Bloomberg)

Summary

It is surprising how far the leadership’s targets seem to be diverging from reality, given the measures planned to achieve them and where the country’s economy stands now.

China’s fundamental challenges—including weak demographics and heavy debts—are indeed tough. But it is also clear that much of what is plaguing China amounts to a nasty cyclical downturn exacerbated by Beijing’s poor policy choices. Tuesday’s big speech by Premier Li Qiang to the National People’s Congress, his first in his new role, gave scant assurance that the government recognizes that—or is willing to change course.

China’s key annual parliamentary session opened today in Beijing, and as usual the premier laid out the accomplishments of the past year and tasks for the year ahead. The big targets themselves didn’t contain any surprises: Like last year, Beijing is aiming for “around" 5% growth, 3% inflation and 12 million new urban jobs.

What is surprising, and worrying, is how far these targets seem to be diverging from reality, given the measures planned to achieve them and where the economy stands now.

Recent research has shed some light on just how far China may be running below its potential growth—i.e. how fast it could grow, with the right policy settings, without overheating. Beijing does face some real fiscal constraints, given how profligate local governments have been over the past decade. And potential growth is clearly heading lower: the downward drift in growth since the mid-2010s, when the working age population peaked, has been especially obvious.

But it also seems very likely that policymakers have overlearned the lessons of past stimulus episodes and now risk a mistake similar to that made by post-2009 Western policymakers: keeping monetary and fiscal policy too tight, resulting in a long period of below-potential growth and employment.

Given how bad things have been, Chinese short-term interbank rates and government bond yields have remained notably high over the past half year: about level with where they sat during the last big downturn in early 2016, when both growth and inflation were still considerably higher.

That might not matter much for the housing sector, where borrowers are sitting out the market because they don’t trust that property developers are still solvent. But it could matter a lot for other borrowing. Economists at the French bank Natixis estimate that China’s real, inflation-adjusted interest rates have since late 2021 been well above the “neutral rate" which would encourage full employment and stable inflation—and that it may take a reduction of close to a full percentage point in real rates to rectify that.

High-frequency employment data from purchasing managers indexes are another clue to just how much slack remains in the domestic economy. Research consulting firm Gavekal finds that a mashup of China’s employment PMI subindexes, weighted by their sectoral heft in the job market, was running far below its long-run average for most of 2023. Nearly all of the drag is from services.

Given how restrictive monetary policy still is by some measures, and that inflation is currently running around zero, it is remarkable to see a 3% inflation target for 2024 and a growth target in line with last year. Fiscal policy doesn’t look like it will get all that much more supportive either. The formal state deficit is budgeted at 3% of gross domestic product. Adding in the proceeds from the planned issuance of special treasury bonds would take that to 3.8%—the same as last year.

Much of China’s real fiscal spending is done off budget by local governments and state-run policy banks, but financing that may be difficult without lower rates—especially if Beijing wants to avoid crowding out already-weak private investment. The premier’s speech did hint at more wiggle room on rates, saying money supply growth should be consistent with growth and inflation targets. That is a subtle change from last year’s call for money supply to rise in line with nominal growth. But Li also called for exchange rate stability and highlighted last year’s avoidance of “flood-type" stimulus in his opening remarks.

Finally, given how much the services sector is still suffering, there was remarkably little trace of it in the speech—it was mentioned exactly four times, once in the context of a “modern" services sector more deeply integrated with manufacturing. On the other hand, “striving to modernize the industrial system" was highlighted as the first major task for 2024.

Li did indicate that some additional government incentives to support consumer spending may be in the works—saying the government would promote consumer “trade-in" programs. Beijing has subsidized car purchases, for example, in previous downturns.

But the government still seems to believe that it can essentially manufacture and export its way out of trouble—even though protectionism is on the rise abroad and there are abundant signs of slack in China’s services sector, which might bounce back strongly with the right push.

Graying citizens, heavy municipal debts and a mangled property financing model are intractable problems. But China’s biggest structural problem may be its increasingly inflexible policy apparatus.

Write to Nathaniel Taplin at nathaniel.taplin@wsj.com

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