The greater the downward pressure on China’s economy, the louder the cries for another round of stimulus. Fortunately, the central government has decided against an all-out boost, choosing instead “smart and targeted regulation” to stabilize growth. This is commendable. But in execution, such work will be challenging. Much will depend on the government’s strategy, tools and goals.
While in London last month, Premier Li Keqiang stressed in a speech that Beijing will not resort to “strong stimulus” to meet its growth targets. Instead, it will “further innovate the thinking and model of macro regulation.” This means taking a “smart and targeted” approach.
Recent government measures echo his pledge. China has indeed entered a phase of “smart and targeted” policy adjustments.
The government is understandably cautious about the use of stimulus, given the limited room for policy maneuver and the lessons learned from the previous round of stimulus after the global financial crisis.
But the more important concern is: just how smart and how targeted will these policy adjustments be?
So far this year, the government has launched efforts to improve the country’s shantytowns and upgrade the urban utilities network, a program for rail construction in central and western China, and measures that benefit farmers and small businesses. The policy measures include relaxing controls to let in more private capital and the targeted reduction of banks’ deposit reserve ratios.
While the government’s attention is undoubtedly focused on the right sectors, the wisdom of its policy choices is open to debate.
Take its attempt to reduce deposit reserve ratios for some banks. That small businesses face great difficulties raising money is a well-known problem. But a liquidity bottleneck is not the cause. Rather, the problem stems from money not flowing into the real economy and distorted interest rates that do not effectively channel funds to where it is needed. To solve these problems, the government should undertake a series of reforms that include lowering market barriers and promoting fair competition. If these reforms are lacking, simply adjusting the deposit reserve ratios will hardly work.
Furthermore, even though the government intended to help small businesses and rural borrowers by cutting the reserve requirement for banks that mainly serve them, in reality this may not be happening. The country’s banking industry is not sophisticated enough for such “precise” policy tools to work. Indeed, there are already reports that the credit easing is instead benefitting steel trading companies and microcredit firms.
The biggest worry is local government debt. Some 21.89 per cent of this debt will mature by the end of this year. As such, many local governments will come under immense repayment pressure, and the risks of default are escalating. The National Audit Office says nine provinces had 821 million yuan in overdue liabilities as of the end of March, after borrowing some 57.9 billion yuan to pay off maturing debt.
Knowing this, the central government has nevertheless included urban commercial banks – which are known to be easily influenced by local government officials – in its latest round of reserve requirement cuts. Whether or not the money will go to small businesses as intended may now rest on how closely the regulator is supervising bank operations.
A spokesman for the regulator has said authorities will review the effectiveness of the reserve requirement cuts after one year. But, in the meantime, if there is no change to how banks operate and no improvement to the quality of its assets, the problem of moral hazard will not be solved – the government will still be expected to play savior in case of a default. This will be the opposite of what policymakers intend.
The recent deployment of various monetary policy tools has raised market concern. China faces the critical challenge of restructuring its economy. In the long term, more attention should be paid to its structural problems. Thus, authorities should be more judicious in the use of monetary tools, deploying them only when reform measures are stalled.
Do macroeconomic adjustments work? Those who say yes make one important assumption: that the government knows best. But the facts show that this is not necessarily true. Otherwise, China would not have needed to embark on market reforms over two decades ago.
At the end of the day, any change will come with a price. China has the capacity to tolerate a slower rate of growth. If these smart and targeted adjustments are to work, the regulator must keep its eye firmly on its goal.
China’s long-term development depends on successful reforms, and not policy adjustments.