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Up Front

China’s NPC recognizes the “new normal” of slower growth

David Dollar

The big news at China’s National People’s Congress (NPC) was that the government set the 2015 growth target at 7 percent, down from 2014’s outcome of 7.4 percent. It also modestly reduced targets for the growth of trade (6 percent versus last year’s target of 7.5) and of fixed asset investment (15 percent versus last year’s 15.7). All of this is a sensible recognition that investment is slowing in the face of excess capacity in many sectors, that the external environment remains soft, and that the slowdown in investment and trade inevitably affects gross domestic product (GDP) growth.

Can China reach these still ambitious targets? Yes, but it will require a careful calibration of macro policies as well as further progress on reform. On the fiscal side, the government has set its stance modestly more stimulative: a fiscal deficit of 2.7 percent of GDP versus 1.8 percent in 2014. This is still quite conservative. At the same time the central government is trying to rein in the borrowing of local government investment vehicles, which amounted to about 4 percent of GDP in 2014. The risk is that too much tightening there will make the overall fiscal stance contractionary. This is China’s version of the “fiscal cliff”—if it stopped the local government borrowing altogether then the fiscal shock would be quite negative. One hopes that the authorities will be pragmatic in their attitude towards local government investment borrowing.

On the monetary side, China in 2015 will need continuing RRR and interest rate cuts, plus domestic liquidity operations, to offset the contractionary effects of net capital outflows. It is striking that China’s balance of payments situation has turned around and in recent months has consistently shown net capital outflows of $50 to $60 billion (USD) per month. The central bank has set the target for M2 modestly lower at 12 percent growth versus last year’s 13 percent. Given the slowdown in real growth plus the very low inflation of about 1 percent, the 12 percent target is generous.

In terms of the reform agenda, I was pleased that some measures are moving ahead, but disappointed about slow progress in other areas. The financial reform agenda seems most advanced. When the central bank recently reduced the deposit interest rate, at the same time it increased the flexibility of commercial banks to offer up to 1.3 times the official rate. Further interest rate liberalization is set for this year, as well as the introduction of deposit insurance. Fiscal reform on the other hand is not moving as fast. There is a need to reform inter-governmental fiscal relations so that local governments have reliable sources of revenue, but progress here is slow.

Another positive development was Premier Li’s announcement that the number of sectors in which foreign investment is restricted would be cut in half. This would be important progress. Unlike the other G20 countries, China is very restrictive about direct investment in the modern services such as finance, telecom, media, and logistics. In a new working paper, I analyze why China should be more open in its service industries. China’s growth will now mainly depend on these service sectors so that having open, dynamic sectors will be beneficial to China.

The rest of the world will feel the shift in China’s growth model away from investment and exports towards more consumption. China will not provide as much demand for energy and minerals as in the past. But it will provide new demand for consumer products and services and that will be a boost, especially to nearby Asian economies. Tourism, for example, has become a major net import for China.  Last year, 100 million Chinese traveled abroad, and this year no doubt even more will go.

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