Round-table discussionApproach may be bumpy, but hard landing
for China economy unlikely, experts say

March 24, 2016

Amid global concerns about the shrinking Chinese economy, Beijing pledged to press ahead with reforms to maintain the country's economy at this year's National People's Congress (NPC). During the annual meeting, Chinese Premier Li Keqiang and other top officials repeatedly reassured the Chinese people as well as global markets and observers that China's economy is not headed for a hard landing.

工藤泰志In a recent discussion on the Chinese economy organized by independent Japanese think tank The Genron NPO and moderated by its president, Yasushi Kudo, Japanese experts agreed that a hard landing for the Chinese economy was unlikely, but that the country was still suffering from various "excesses" and time would be needed for the structural reforms to take effect.

Masahiro Kawai, a professor at the University of Tokyo's Graduate School of Public Policy, said the downward pressure on the yuan is one of the immediate problems facing the Chinese economy. The devaluation of the yuan by Chinese monetary authorities in August 2015 stoked fears in financial markets that the Chinese economy was actually taking a turn for the worse, Kawai said.

He said as the yuan's weakness continues and U.S. interest rates head higher, Chinese companies that have borrowed heavily in global dollar debt markets are moving to reduce their exposure to dollar debt, causing massive fund outflows and further pressuring the Chinese currency. Last year, China failed to reach its 7 percent economic growth target, marking 6.9 percent growth in 2015. "That isn't a bad figure, but the market took it negatively, triggering further capital outflow and downward pressure on the yuan," Kawai said.

But contrary to market perceptions, Kawai said it is unlikely that the yuan will weaken to a point where it will be forced to go through another devaluation since China maintains a trade surplus and the foreign debt of Chinese corporations is very small compared to the government's sizable foreign reserves.

Meanwhile, Osamu Tanaka, executive vice president at the Policy Research Institute of the Ministry of Finance and special research fellow at the Japan-China Organization for Business, Academia & Government Partnership, said that China is trying to shift its economic structure from that of rapid growth to moderate growth, a process that requires major structural adjustments and reforms. At the same time, China is experiencing an economic slowdown amid the general global economic fragility and a drop in global demand as well as domestic overcapacity that curbs capital investment. The fact that these two phases are occurring simultaneously makes it look like the Chinese economy is doing much worse than it actually is, Tanaka said.

Koji Sakuma, general manager and chief economist of the Economic Research Development and Emerging Economy Research Department of the Institute for International Monetary Affairs, said with the sudden drop in global demand, China had to "rev up" its economic growth engine to forcibly create demand. And with the weakened global economy dependent on China's drive, the world panics when China's economy starts to slow down. "In a way I feel sorry for China," Sakuma said. "It is merely trying to slow down the economy and conduct structural adjustments. This move doesn't pose any risks and is far better than the days when there were no efforts to implement structural reform."

Structural adjustment amid excess capacity

China's 4 trillion yuan fiscal stimulus in 2009-2010 to boost the economy and domestic demand resulted in excess equipment and capital, and China is trying to absorb this excess through supply-side reforms, Kawai said. That would include cleaning up the so-called "zombie" state-run companies, the hugely inefficient and unproductive public-sector companies that have managed to survive thanks to abundant government subsidies.

While such measures cannot take place overnight, and the government needs to provide leverage through fiscal and financial measures, Kawai said that Beijing is fully capable of implementing them as the government's debt to GDP ratio is small. "What's important is that China repeatedly shows that it has the ability to solve its problems by actually carrying out the promised reforms," Kawai said.

Tanaka added that the debt to GDP ratio of the central and local governments combined remains at about 40 percent, not a figure that would trigger any immediate defaults. "The Chinese government is trying to support the economy by concentrating investment in areas where it's truly necessary," Tanaka said.

Meanwhile Sakuma warned that the domestic yuan debt of China's public and private sectors combined is growing to dangerous levels. "As the economy slows down, the issue of bad debt would likely become more prominent, and unless the Chinese government manages to properly dispose of its bad debt, China may suffer from a prolonged economic downturn like Japan suffered in the past," Sakuma said.

The 13th Five-Year Plan for the 2016-2020 period, approved by the NPC on March 16, states the Chinese government's determination to tackle supply-side structural reforms and to maintain 6.5 percent economic growth for the next three years. One major concern in implementing the structural reforms is the potential loss of 1.8 million jobs in the iron and steel coal sector alone. Add job losses in other industries facing restructuring and the figure could reach several million, posing a serious threat to the nation's economy, experts say.

The Chinese government plans to provide fiscal stimulus to support the economy through measures such as unemployment allowances, tax breaks for firms and individuals as well as long-term investment in public works, such as railways and expressways. It, however, pledged to keep its budget deficit within 3 percent of GDP, hence any stimulus measures will be capped under the promised figure. While the market may view this amount to be insufficient, a stimulus package that is too big is merely going to help the "zombie" companies to survive, Kawai said. The reforms announced at the NPC show that the Chinese government is planning a balancing act between substantive reform and stable economic growth, Kawai explained.

Tanaka praised the central government's efforts to resolve the real estate problem by providing low-rent housing to migrant workers who have moved into cities from rural areas and are not able to afford decent housing. But Tanaka pointed out the need for the government to tackle the country's two-track pension system for the measure to be truly effective. The Chinese pension system offers a different scheme for employees of urban enterprises compared to a more general one that covers rural and urban residents, and migrant workers who try to switch from the urban system back to their rural hometown system face difficulties or may even lose money.

Meanwhile, Sakuma said Prime Minister Li's annual Work Report delivered at the NPC was comprehensive in that it grasped the problems the country faces and clarified the methods to tackle them. Sakuma in particular noted the reform of state-owned enterprises, saying that one needs to keep an eye on whether these reforms will indeed take place and whether measures on the demand-side will be implemented to ease the blow to society when the supply-side reforms take effect. "That is important for the stability of Chinese society," Sakuma said.

Short-term restrictions necessary to stabilize the yuan

The International Monetary Fund agreed last November to include the yuan in the benchmark Special Drawing Rights currency basket amid China's campaign to globalize its currency. Asked whether China needs to tighten capital controls, Sakuma said that while new regulations were probably unnecessary, there is a need to make sure the current rules are being obeyed. Ever since the "Lehman Shock," the yuan has been dragged along by the U.S. dollar and has remained too strong, and that is causing the current downward pressure on the yuan. So tightening regulations in the short term would avoid needless confusion in financial markets, Sakuma said.

Kawai agreed with Sakuma, citing the recent massive capital outflow for hampering government efforts to carry out reforms. "In the medium and long term, the markets must be liberalized, but given the current circumstances, I think it's very important to take measures to stabilize the yuan," Kawai said.

Unlikely hard landing for the economy

With China being a net creditor nation, the Japanese experts said the chances of the Chinese economy heading for a hard landing were highly unlikely. But Sakuma said the key to soft-landing the economy is to delve into the realm of politics. In order to stimulate domestic demand and shift to a consumption-led society, the Chinese economy needs to develop its service sector, particularly in the urban economic areas. "Such an economic model is only feasible if the general public is able to make free choices, and China will eventually have to deal with such issues or else the reforms will go nowhere," Sakuma said.

Tanaka said the Chinese government is trying to take advantage of the external pressure from the global community such as those expressed at the meeting of financial leaders from G-20 nations to conduct the much-needed structural adjustment. But such major reforms cannot be achieved through the efforts of the government alone. The Chinese Communist Party needs to step in to help with the reforms, and central authorities need to be careful not to alienate the local authorities with too much interference. "What's important is the balance between maintaining the incentive of the local authorities and pushing ahead with the various reforms," Tanaka said.

Kawai also said a hard landing for the Chinese economy was unlikely as China's fiscal condition was good enough for it to be able to increase fiscal stimulus if the economy deteriorates. He said China's "New Normal" policy of economic and social stability, which entails a shift from an investment-oriented society to a consumption-oriented one, will allow for stable growth in the medium and long term, if successfully implemented. "The service sector is steadily growing, much faster than the manufacturing sector, so if this trend continues, this sector will be able to take in the people that were forced to leave the manufacturing sector," Kawai said.

In closing the discussion, the three experts said developed nations also needed to implement structural reforms in their countries and not depend on the economic strength exhibited by developing nations such as China to support their economies.

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