By EO Editorial Board
Issue 628, July 15, 2013
News, page 1
Translated by Zhu Na
Original article: [Chinese]

As China’s economy continues to spiral downward, it begs the question of whether the new government has a limit on what it will tolerate before it intervenes.

On July 9, Premier Li Keqiang answered in the affirmative at his third provincial economic forum since taking office. He said for the first time that the government needs to let the economy run its course in a “reasonable range” that keeps economic growth and employment above the "lower limit" and inflation below the "upper limit.”

The Shanghai and Shenzhen stock markets rose after hearing the news, with the Shanghai Composite Index rising above 2,000 points. The market believes Li’s remarks show that the government is willing to sacrifice short-term interests in order to promote a structural adjustment, but it won’t accept too great of an economic downturn or a hard landing.

These words greatly increased the certainty surrounding future policy in the Chinese economy, which allowed the cloud over the market to temporarily fade.

In our view, the “upper limit” and “lower limit” put forward by Premier Li actually reflect the goals of the government work report, including GDP growth of around 7.5 percent, inflation of 3.5 percent, an urban unemployment rate lower than 4.6 percent and more than 9 million new jobs.

These targets were announced over 100 days ago, but the fact that the market reacted the way it did to Li’s remarks indicates that there’s been a lot of second-guessing and misunderstanding of the government’s intentions.

One misunderstanding is that structural adjustments preclude maintaining growth. The thinking is that the government would be willing to give up growth in order to adjust the country’s economic structure. The severe “credit crunch” that many financial institutions recently encountered at the hands of the Central Bank provided evidence for this view.

The decrease of exports and imports in June, as well as the heightened loss expectations at state-owned enterprises and small and medium enterprises in the first half of the year, indicated that the economic downturn had worsened. Moreover, during the second quarter GDP growth fell to 7.5 percent, meaning it had already sunk to the government’s 2013 goal and the apparent “lower limit.” This was down from 7.7 percent the previous quarter, making it the ninth quarter out of the past ten that growth slowed. 

Whether economic growth has a “minimum guarantee” has become a big question in the market.

When summarizing Li Keqiang’s “Likonomics,” overseas investment banking institutions have forecasted that China’s economy may experience a temporary hard landing with GDP growth dropping to as low as 3 percent one quarter. 

Li Keqiang made his "reasonable range” remarks at this time recognizing the necessity of a “minimum guarantee.” At the same time, it was also a way of explaining that structural adjustment and maintaining growth are mutually reinforcing.

The government has realized that the ups, downs and pains brought about by structural reform are inevitable. Structural adjustment means economic slowdown, but it creates a relatively stable economic and social environment and also creates conditions for the introduction of new reforms. This is the key to keeping economic growth and the employment rate above the “lower limit.”

However, even though the “minimum guarantee” signal is clear, we don’t think policy will fall back into its old habits; which consist of the government pumping stimulus money into often inefficient investments and then hoping to go back and solve the problems it created itself. Such a cycle can’t continue any longer. For the market to believe another routine stimulus is in the works would be another misunderstanding. 

As long it makes sure the economy is operating within a “reasonable range” the government should seize the opportunity to promote structural adjustments and industrial upgrades that involve lowering production capacity, deleveraging, more rapidly turning economic activity controlled by the state over to the market and society, and ridding the system of obstacles that inhibit economic progress.

Of course, structural reform is a long and painful process. However, we have always believed that the way to resolve pain is not to slow down. The more we are able to grasp opportunities to speed up reform, the less time and pain Chinese enterprises and the public will have to bear. In the long-term, this is the only choice.