Fall is on its way, and with it comes preparations for China's Party Congress. Leaders in Beijing will begin making and setting plans for economic goals and targets for 2016, which they will announce next Spring. With the planning comes leaks, forecasts, and speculation by China watchers around the world. This Fall's big worry will be the potential for another target growth drop to 6.5% from 7% this year. 2016 targets will not be announced until next Spring, but as enough consensus builds in the market for a growth target drop, risk assets and commodities will see more upheaval.
Here are 3 reasons why a China target growth rate cut to 6.5% is highly probable:
1. Maintaining a higher rate of growth than necessary to maintain stability gets more costly each year.
Reflation per increased unit of GDP growth is growing more costly over time, both in terms of actual costs (budget deficit, bank costs from NPLs) and indirect costs (higher debt burden from monetary stimulus, financial repression from a weaker currency and lower deposit rates). The fact that Beijing has done the bare minimum stimulus needed this year to stoke growth towards the 2015 target shows that policymakers are very aware of the costs and declining benefits of stimulus.
Each easing cycle meant to push growth to a politically mandated growth target brings a surge in the debt burden, NPLs, overcapacity, and pollution. When China's non-sovereign debt-to-GDP was around 100% or so, easing was not a problem. Now, with debt still growing faster than GDP, each increase in credit to spur growth pushes debt deeper into the 200% plus territory. The incremental improvements in overall growth may not be worth the increased debt burden and the risks that burden creates. In addition to the overall debt burden, NLPs are rising - up 11% in the second quarter - increasing with each round of easy credit.
Fiscal stimulus is usually directed to sectors that boost polluting and overcapacity - heavy industries like steelmaking and construction materials for example. Public money flowing to those industries adds to China's existing problems and pushes against structural reforms and pollution fighting measures.
A cut to 6.5% will reduce costs involved with fiscal and monetary measures, and will allow policymakers to save some dry powder for future potential economic risks.
2. A lower growth rate will help with the "war on pollution".
After years of China's rapid growth at the expense of air and water quality, by 2013 a series of events commonly referred to as "airpocolpyse" moved pollution to the top of the list of reasons for protests, beating out land expropriations. Political degradation and the unrest it caused led to 2014's "war on pollution". But, this year a Berkely Earth study estimated air pollution accounts for 1.6 million deaths a year. On top of that, a recent NASA study named the Northern China Plain, one of China's most densely populated and economically important regions which includes Beijing, as one of the world's fastest deteriorating aquifers. China's air is poisonous, its water polluted and scarce, and the result is 30,000 to 50,000 "mass incidents" of protest every year.
Lowering the growth rate to 6.5% will help with the pollution fight and therefore take some pressure off of social dissent. More dissent has been caused by pollution than growth already slowing below 7% this year.
3. Service sector employment growth is keeping employment stable at lower overall growth rates.
If you strip out the transient surge in financial services from stock market activity, China has been growing at about 6.5% so far this year already, and we have not seen the widespread employment problems that Beijing's leaders worry over. One possible explanation is the continuing fast growth of service sector employment as services grow well above 8%.
For China's policymakers, employment stability is of paramount importance. The legitimacy of the country's political system depends on the Party's ability to maintain stability and prosperity. Massive and sudden joblessness would put that legitimacy in jeopardy. The underdeveloped service sector has been a source of fast employment growth for years. The net workforce increase in the service sector for the five years to 2013 (the latest data) averaged 9 million jobs a year. That compares to 5 million jobs a year in industry, and a decline of 11 million jobs a year in agriculture. The recent renewed shift of investment into services will keep that trend on track (see the chart to the right).
This year has illustrated that China's growth can run below 7% without triggering the widespread employment instability that frightens Beijing's policymakers. As long as services and consumption rapidly grow from an underdeveloped state, growth around 6.5% can be tolerated.
What will another growth target rate cut mean for China's economy?
China doesn't need a hard landing for industrial machinery and commodity exporters to suffer. It only needs a significant slowdown in industry after years of double digit growth, which is what we have seen so far in 2015.
China's policy directed slowdown is highly uneven. Services and consumption continue to grow at a fast clip. Industry and construction have decelerated sharply. The reason for this is the dual task of slowing trend growth to facilitate a soft landing while at the same time rebalancing the economy to grow the underdeveloped the consumption and service sectors. China's service sector accounts for 48-49% of GDP. EM peers, including Korea, Brazil, and Turkey all have service sectors above 60% of GDP. Faster services and slower industry will help make headway on the "war on pollution" as well as slowly remove overcapacity in a number of heavy industries.
China Import Categories as an % of Total
Going forward this trend will continue. A lower target rate of 6.5% GDP growth will result in a disporoprtunate deceleration in industry as services only modestly slow. China is the workshop for the world's consumer goods, and faster consumption has few beneficiaries outside of China (see pie chart). Services also have few beneficiaries outside of China. But, commodity and industrial machinery exporters will feel more pain as the industrial sector moves from just below 6% this year to around 5% next year.
The map below illustrates countries reliant on China demand that will be subject to further slowing in China's industrial sector.
经济硬着陆
中国硬着陆
软着陆