Slowing economy: challenges before Chinese govt

China’s slowing down of growth rate to register 6.6 in January 2019 in the last 28 years has raised several eyebrows among its policy makers, economists and government. Cooling of its economy could be a signal of its saturation in domestic consumption driven model as well as its incessant trade skirmishes with the US.

Faltering domestic demand and escalating import duty by US are putting enough pressure on Chinese government to adopt some concrete measures so that the economy is brought back on the track.

A recently-conducted Politburo meeting of the Communist Party has emphasised the need for the Chinese government to resort to several measures which could drive the beleaguered economy. First and foremost, could be fine tuning its economic policies by adopting counter-cyclical measures.

This means the government must adopt accommodating fiscal policies by increasing aggregate demand by investing in the economy as well as cutting tax rate so that disposable income with the consumers go up to make economy temporarily consumption driven.

Similarly, expansionary monetary policy may be created by lowing interest rate to make borrowing easier. All this becomes effective assuming China enters some positive negotiations with the US to make trade friction risks remain under control.

Second, the issue of global climate change and increasing carbon emission by Chinese industry are drawing serious attention of global leaders where developed and industrialised countries are exerting lot of pressure on Chinese government to reduce such emission.

As proposed in the Paris convention of global climate change, many of the promises made by developing countries are not kept. China is currently trapped between the issue of clean environment versus growth.

One can establish cleaner environment by not indulging itself in industrial pollution, but industrial pollution is resultant of economic growth. So, the question is where to compromise and how to make a trade-off?

In a bid to clean up the environment, the government decided to close some of the high polluting production facilities in China. Such closure put downward pressure on the economic activity and also created financial risks plant owners and investors.

This led to a reduction of total social financing and cooling off of economic activities. What government needs to adopt is to use renewable sources of energy and indulge in eco-friendly activities.

Third, China’s desire to reach ‘upper middle income’ group of countries is well recognised. China’s GDP per capita rose from $3,600 in 2007 to almost $9,000 in 2018 (World Bank) has definitely lifted many out of abysmal poverty, but has raised the wage cost ultimately losing its low-cost advantage. Therefore, China must build new industries through innovation, artificial intelligence (AI) and robotic technology. Industrial upgrading could be the answer as this would support the next phase of its economic development. Moderation of growth will likely continue until this battle between old and new industries ends.

Fourth, another agenda of the government has been to control systemic financial risks in order to register higher economic growth. To reduce such financial risks, regulatory authorities took measures to control shadow banking transactions.

This, in turn, has affected many private players. Some of them have failed to meet the stringent industry standards as a result they have been shut down.

Though government pleads that it never targeted private enterprise, apparent argument is that it was largely due to the pressure coming from SOEs (state owned enterprises) who still call the shots in decision making process. The government is trying to appease the private sector by reversing policy towards them and reiterating its importance in the Chinese economy.

The trade friction with USA is seriously affecting investor confidence and probably delaying planned business investment. It is believed that longer the friction continues, it is going to drag the economy to an extent that a loss of about 0.6% of China’s GDP can be realised.

Fifth, the government is interested to formalise an environmental policy which should convince developed world about its reduction in carbon emission. It is also proposed that China and USA may reach some partial agreement on trade friction during the second quarter of 2019, although a full resolution is unlikely in the near future.

Both the governments may strike a deal where trade balance may be arrived at. It is possible that the USA may insist on opening up of China’s services sector and improving protection of intellectual property rights which have been long overdue after China becoming a member of WTO in 2001.

Sixth, the government must pay attention towards creating more flexible policies. To strengthen monetary policy independence, the People’s Bank of China should consider either increasing exchange rate flexibility or tightening management of cross-border capital flows.

Fiscal risks

Some policy makers are worried this could increase fiscal risks if the fiscal deficit exceeds 3% of the GDP. But in reality, consolidated government debts are still about 50% of GDP — a 3% fiscal deficit should not become a hard constraint for the government.

Lastly, the government may create some kind of a special purpose vehicle to take over some of the borrowing to cut off inefficient financial flows and take more time to deal with stocks. More than two decades ago, many Chinese banks had large amount of bad loans.

To diffuse the situation, the government created asset management companies, which purchased significant worth of bad loans from the banks. This exercise could relieve the banks of their debt burden and initiated a process of restructuring.

May be there is a merit in the case for the government now to undertake such a measure to put the economy back on the rail. There is definitely a lesson for India to think in terms of controlling NPAs thorough this measure.

(The writer is Professor, Lal Bahadur Shastri Institute Of Management, New Delhi)