China’s two-week-long National People’s Congress will begin on Wednesday. Along with the NPC meeting, the Chinese People’s Political Consultative Conference (CPPCC) begins today.

During the NPC meeting, the congress will review and vote on the following reports:

The government work report (the Politburo reviewed and discussed this report on February 24);

The report on the implementation of the 2013 plan for national economic and social developments and on the draft 2014 plan for national economic and social developments;

The report on the implementation of the central and local budgets for 2013 and on the draft central and local budgets for 2014;

The work report of the NPC Standing Committee;

The work report of the Supreme People’s Court;

The work report of the Supreme People’s Procuratorate.

The two main issues to watch for at the NPC meetings are: the major economic targets for 2014, and reform measures to be taken in 2014.

Economic targets

The Central Economic and Working Conference held in December is a tone-setting economic meeting attended by top Chinese leaders. During that meeting top leaders vowed to seek steady economic progress through more reforms. It reiterated adoption of “proactive” fiscal policy and “prudent” monetary policy in 2014. Overall, we expect the government will stick to economic targets similar to those of 2013.

GDP growth: “about 7.5%”

Although the government has toned down the importance of GDP growth, it remains the most important economic indicator to watch out. The new leaders are more willing to tolerate slower growth for better quality. In our view, there are good reasons to lower the GDP growth target to 7 percent in 2014, because:

It is consistent with the 12th Five-Year Plan growth target (7 percent in 2011-2015) and longer-term target of doubling GDP between 2010 and 2020;

It will provide more room for structural reform, which will support long-term growth but could drag near-term growth.

However, based on recent observations, it is likely that the government will keep the growth target at 7.5 percent (possibly adding “about”) in 2014. For instance, local governments have recently held People’s Congress. While most of them lowered 2014 growth targets (to below actual growth in 2013), the minimum GDP growth target at local levels is 7.5 percent (for Beijing and Shanghai). In addition, Premier Li Keqiang has mentioned in various cases that 7.2 percent is the growth floor to ensure that unemployment rate will stay at reasonable levels.

CPI inflation: 3.5%

The government has reiterated the importance of an upper bound (inflation) and a lower bound (employment) in its economic work. In 2013, CPI inflation averaged 2.6 percent, significantly lower than the 3.5 percent target. We expect inflation to drift up to 3.0 percent in 2014, still comfortably lower than the government target (expected to remain unchanged at 3.5 percent). This means that inflation is unlikely to become a priority policy consideration. On the positive side, the low inflation pressure provides a favorable environment to proceed on resource pricing reform and other structural reform.

M2 growth: 13%

M2 growth printed at 13.6 percent in 2013, exceeding the government target of 13 percent. We expect M2 growth will slow down to 12.8 percent in 2014, and the target will stay unchanged.

Our interpretation of the “prudent” monetary policy in 2014 is that policy rates and reserve requirement ratios (RRR) will stay unchanged, but credit slowing that started in the second half of 2013 will continue in 2014. Although the People’s Bank of China no longer announces a loan growth target, loan quota continued to be used in its window guidance operation. We expect new loan creation at 9.8 trillion yuan (US$1.6 trillion) in 2014 (vs. 8.9 trillion yuan in 2013, or 13.8 percent vs. 14.1 percent in growth term), and total social financing at 18.5 trillion yuan (vs. 17.3 trillion in 2013, or 16.2 percent vs. 17.8 percent in growth term).

Fiscal budget

In 2013, the government set the fiscal deficit target at 1.2 trillion yuan. The actual fiscal deficit came out to be 1.06 trillion yuan, about 1.86 percent of GDP.

We expect the 2014 fiscal deficit to stay unchanged at 1.2 trillion yuan, or about 1.9 percent of GDP. The bias is tilted toward upside if considering that the quota for local government bond is likely to be lifted (350 billion yuan in 2013).

However, it is more meaningful to also include “fiscal deficit” at local levels (i.e. local government debt) when assessing the fiscal policy stance. If adding fiscal deficit at both central and local government levels, the so-called augmented fiscal deficit could be as high as 8.8 percent of GDP in 2012 and 8.1 percent in 2013 (JPMorgan estimates). In 2014, we expect the government will contain the pace of further increase in local government debt, bringing down the augmented fiscal deficit to 6.5 percent of GDP (no target will be announced). In that sense, fiscal policy has a tightening bias in 2014.

Structural reforms

The Third Plenary Session of the 18th Communist Party of China Central Committee outlined an ambitious reform agenda, with most tasks scheduled to be completed by 2020. As the starting year of the new grand reform, what will happen in 2014 is closely watched out. We think reform is serious, yet the key features of macro policy for 2014 will evolve around the balance between structural reforms and near-term growth stabilization.

The sequencing in economic reforms will affect the growth outlook in 2014. Judging from the near term impact, some reforms, including the removal of government administrative controls and opening private sector investment (e.g. in the service sector, financial services, telecommunications), could generate new sources of growth.

However, credit slowing, tightening on local government debt/expenditure, production adjustments to correct for overcapacity in a few key manufacturing sectors, among others, could drag on near-term growth momentum (as have been reflected in recent data). The tradeoff between reform and growth implies that those reforms with neutral or positive near-term impact could progress faster, including administrative reform, fiscal reform, financial reform, resource pricing reform and easing the one-child policy. By contrast, for other challenging tasks (such as rising debt and overcapacity) it is less likely to make significant progress in 2014, and the near-term objective will focus more on containing the tail risk rather than problem-solving.

The Central Economic Working Conference held last December confirms the above understanding. The top leaders listed six major tasks in 2014:

Ensuring stable supply and quality of agricultural products and food safety;

Speeding up industrial structural adjustment and resolving overcapacity problems;

Preventing and containing risks from local government debt;

Pushing for coordinative regional developments;

Raising average living standard and improving social welfare;

Further opening up the economy and pushing ahead with free trade zone negotiations.

These tasks have two main purposes: to foster new sources of growth (task 2, 4, 6) and to maintain stability and contain downside risks (task 1, 2, 3, 5).

In addition to economic issues, the NPC will also touch on other issues, such as anti-corruption, environmental protection, improving the legal system, cultural system and social governance.