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China set to meet target on upswing in business circle
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China’s economy is growing closer to trend. The business cycle is on an upswing and will ensure that the economy grows close to the government’s target. The Third Plenary Session of the 18th Party Central Committee is expected to bring important reforms that will continue to turn China into a market-based economy.
From 2011 to mid-2013, the economy underwent a period of implicit monetary tightening as the government tried to deflate a housing bubble and crack down on the shadow banking sector. The results were an appreciating currency, higher bond yields and real interest rates, and ultimately slower economic growth.
Policy tightening was compounded in June with speculation of the US Federal Reserve’s tapering its quantitative easing program, which siphoned off liquidity from China’s banking sector as long-term interest rates rose in the US and funds flowed back there. This briefly pushed China close to a financial crisis: Interbank lending rates spiked — Shibor, the Shanghai interbank offer rate, reached a record 13.4 percent on June 20 — and the 1-10 year government bond yield spread turned negative.
Given the real possibility of a deep recession, the government caved and backtracked on its policy of credit tightening.
The central bank issued a statement pledging to “safeguard stability” in interbank markets and counter “seasonal and emotional factors,” and resumed injecting cash into the economy. The government launched a mini-stimulus of small business tax cuts, easier financing rules for exporters, and a pledge to boost railway investment.
The result was a third quarter bounce, with GDP growth accelerating to 7.8 percent, up from 7.5 percent in the second quarter. The monthly indicators that Premier Li Keqiang reportedly looks at — electricity consumption, rail freight and bank lending — also point to an upturn in the business cycle.
Higher fixed investment will boost industrial production in the fourth quarter, and the trend suggests the government’s 7.5 percent full-year GDP growth target is within easy reach. We expect the economy to grow 7.6 percent this year and 7.5 percent in 2014.
Our baseline GDP growth forecast for the medium term is for a steady deceleration in line with China’s potential rate because of China’s aging demographics and diminishing returns from adding capital to labour. This forecast has many assumptions, the strongest being that the government is able to implement a reform agenda and keep China from falling into a middle income trap.
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