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January 29, 2015

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Economist: Challenges facing China’s slowing economy require savvy policies

EDITOR’S note:

On the sidelines of a recent forum held by Fudan University’s School of Management, Ha Jiming, acclaimed economist and managing director of private wealth management in the investment management division of Goldman Sachs (Asia) LLC, spoke to Shanghai Daily reporter Ni Tao about the prospects for China’s economy in 2015.

Q: As the Chinese economy slows down, what are the major uncertainties that lie ahead in 2015?

A: The uncertainties are mainly reflected at a policy level. It is said that fiscal policy will become more active, but how active remains to be seen. And will monetary policy be tightened or relaxed? And to what extent?

Will economic reform be initiated as the market anticipated? Generally speaking, the economic fundamentals have more certainties to offer.

Regarding the scourge of overcapacity, will the government boost investment to fuel growth, especially in infrastructure? The problem is, how can we fund the investment? With borrowed money, probably. But ultimately, contrary to our expectation, investment as a share of GDP may not drop, but rise instead.

New investments will continue to be marred by inefficiency if the reform doesn’t go far enough.

As for the real estate sector, pressure is building in some cities, with quite a few even speeding up construction of affordable housing. As a result, not just commercial properties will languish unsold, affordable housing might suffer the consequences of redundancy as well, compounding the already severe overcapacity. Such risks do exist.

Q: China’s economy grew 7.4 percent last year, the slowest in a decade. How do you see the so-called “normality” of slowed growth? And what is the ideal range of GDP growth?

A: The 7.4 percent growth rate was achieved not without strenuous efforts. The past year witnessed the adoption of a host of government policies aimed at meeting the growth targets.

It seems that overhaul of structural problems remains slow. For instance, China’s investment-to-GDP ratio is about 50 percent, a figure that is excessively high whether in a historical or global context. At its peak, Japan’s investment represented 40 percent of its GDP. The staggering ratio is accompanied by mounting debts and declining investment efficiency. Therefore, I think the government will strive to reduce investment, so as to build a more balanced economy.

To reach this goal, growth has to moderate. My prediction is, if the proportion of investment as a share of GDP falls to 40 percent over the next seven to eight years, the annual GDP rate will slow to between 5 and 6 percent. However, if this is deemed too slow, and 7 percent or higher is more desirable, it is attainable, but only through further investments that lead to a heavier debt pile. In that scenario, the ratio of China’s debt to GDP will rocket from more than 200 percent to well over 300 percent, rendering the economy fragile, heavily leveraged, and prone to debt crises.

Q: What adjustments might be in store for monetary policy in 2015?

A: I believe there is room for monetary easing. After all, inflationary pressure isn’t big, with PPI (producer price index) decreasing for years. Monetary easing might help to relieve debt pressure. Otherwise, deflationary pressure will bear down on businesses. With leaner profit margins, high interest rates as well as flattening prices of their products, they will fall on hard times.

Hence, monetary easing is a possibility and the ways to do it are myriad, not necessarily restricted to sweeping cuts in reserve requirement ratio (the amount of money banks are ordered to hold in reserve.)

As we have noticed, Beijing made a few targeted cuts in reserve requirement in the past year.

China redefined the loan-to-deposit ratio in a way that allowed inter-bank deposits to be recognized as loans. And such deposits are exempted from cuts in reserve requirement. This amounted to de facto lowered reserve requirement, albeit in a different form. Although the possibility of a systemic reduction cannot be ruled out, there are plenty of ways to execute monetary easing.

Q: The property market was lackluster in 2014. Will it see some sort of turnaround in 2015?

A: I think the property market will continue to be anemic this year. As baby boomers reach retirement age, they will be less inclined to buy property; instead, many will increasingly seek to sell property. Property will be less in demand. Of course, China’s ongoing urbanization might be a game changer, for it promises to prop up property prices. But we ought not to overestimate the pace of urbanization, because this process entails huge prior investments and costs.

A migrant who settles in town and enjoys the same entitlements to education, health care and social security as the urbanites requires that the government spend lavishly.

At the moment, local finances are not in good straits, so the spending won’t be coming soon. What’s more, the exploitation of urbanization as a driving force of real estate seems to have run amok in some localities.

The overall floor space currently under construction in China totals 4.8 billion square kilometers, and at the current pace of urbanization, it will take roughly eight years for the market to absorb this excess supply.

After the regulatory overhaul last year, I don’t think a property market boom is on the horizon.

Q: Could you predict the movement of the yuan?

A: Over the long run, the yuan might face some downward pressure on its value, because at home its purchasing power is weak and is still declining. Take China’s BigMac Index (an informal way of measuring the purchasing power parity between two currencies). If you compare China’s BigMac price with that of foreign countries, you will find it is higher. That means the yuan is a weak, devalued currency at home. But over the years, it has been slowly appreciating abroad, even against a strong dollar.

As such, this paradox — domestically weak and globally strong — has to be addressed. One way to do this is to depreciate the yuan overseas.

Moreover, can China retain its position as a surplus nation? Countries such as Japan have turned from a surplus nation into a deficit nation.

China’s labor cost per capita has been steadily rising and has outstripped that of some countries, for example, Thailand. In the early 1990s, Thailand’s labor cost per capita was 5.4 times that of China, but now it has dwindled to 0.7 times as much. In the long term, China’s labor-intensive industry and exports will shrink, followed by an exodus of businesses.

If China still lags behind in its capacity to produce high value-added goods, its trade surplus will continue to narrow, and eventually turn to deficit, exerting pressure on the currency to depreciate.

To sum up, the yuan might depreciate in the long run, but steep depreciation is temporarily out of the question, as China sits on a foreign exchange reserve of US$4 trillion. In the event of considerable depreciation pressure, the People’s Bank of China is fully capable of stabilizing the exchange rate. Nonetheless, as China is trying to liberalize the formation mechanism of the yuan’s exchange rate, it won’t intervene as often as it did before. There may be greater volatility in terms of foreign exchange rate changes this year, but ideally within a stable range.

Q: In which area do you expect the reform to be most successful?

A: Personally, I’m most optimistic about reform in the marketization of interest rates, that caps on interest rates can one day be removed.

Another area where the reform is likely to succeed is overhauling the formation mechanism of the yuan’s exchange rate, to enable it to become a more global currency. So far we haven’t seen a single currency that is not freely convertible but has international clout.

In April, the IMF will weigh in on the proposal to include the yuan in the Special Drawing Rights (SDRs), which now comprise four currencies — the pound, the dollar, the euro and the yen. All of their exchange rates are determined by the market. For the yuan to join the SDRs club, progress needs to be made to enhance its free convertibility.

More needs to be done in reform of state-owned enterprises. Some of them do report profits, but largely thanks to monopoly. If they can be made to cede market shares to private capital — more as influential stakeholders than as mere participants — I believe our economy will be functioning with higher efficiency.

As I said before, to sustain growth, one way is to increase spending, but an alternative is to raise the efficiency of spending without having to spend more. The second choice is preferable.



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