In Part 2 of our series on the 13th five-year plan, Sandra Heep explains why China’s ambitious growth target will exacerbate many of the country’s economic problems. She argues that 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 income 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 economic 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 challenges.
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. The most concrete measure the plan contains 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: according to Shang, the government is considering debt-for-equity swaps to reduce the corporate debt burden. These swaps would allow commercial banks to convert the non-performing loans in their books into stock holdings. 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.
Infrastructure spending will drive up public debt
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 scheduled for completion by 2030.
At least this time around local governments will not have to bear the brunt 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 on the sidelines of the NPC. Yet despite this shift in spending responsibilities, local government debt will continue to rise if Beijing fails to implement long-awaited tax reforms aimed at putting local government finances on a firmer footing.
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 middle-income trap.