China Cuts Economic Growth Forecast In Annual Report: Here Are The Key Changes

As part of the previously previewed “Two Sessions” which started on Sunday, Chinese Premier Li Keqiang on Sunday delivered the annual report on the work of the government in Beijing, summarizing the country’s achievements in the past year, and setting goals for this year. In his policy speech, lasting 97 minutes and 18,600 Chinese characters, Li signaled a course adjustment for the world’s second-largest economy and some important changes in tone.

A 90-second summary of the key highlights from Li’s Two Sessions address is shown in the clip below:

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While the full breakdown of proposed economic and policy changes is below, here is a rundown of the 5 top takeaways from China’s economic realignment, per Dow Jones:

  • #1: Politics Is in Command

Though Mr. Li took center stage, President Xi Jinping is clearly in charge. Mr. Li’s policy address contained eight mentions of Mr. Xi, some including his new title as “the core” of the Communist Party leadership. Not since Mao Zedong more than 40 years ago has a serving leader gotten so many shoutouts in the policy address. It shows Mr. Xi’s strong hand going into a Communist Party Congress later this year to chart the course for his second five-year term.

  • #2: Growth Matters

Keeping the economy humming at a fairly high rate is still a priority. Mr. Li set this year’s growth target at “around 6.5%,” a shade slower than the last year’s range of 6.5% to 7% and actual reported growth of 6.7%, the weakest pace in a quarter century. Still, Mr. Li added that growth should be “higher if possible.” The faster tempo is needed, he says, to create jobs and raise living standards.

  • #3: Restructuring Matters Too

The emphasis on growth means that putting the economy under the much-needed restructuring the government has stressed for years is taking second place. Mr. Li recommitted to efforts to reduce excess capacity in the steel and coal sectors, pare down corporate debt and make housing affordable for first-time buyers. The going is likely to be slow: “Stability is of overriding importance.”

  • #4: Signaling Changes

The government looks to domestic demand, and consumer spending in particular, as a new engine of growth. While government outlays for health care, education and pensions are getting a minor boost, policies to promote domestic demand are more geared to businesses than households. Tax cuts and exemptions are being doled out to smaller firms and startups. An exception: no more mobile roaming and long-distance fees on domestic calls.

  • #5: A Trump Effect

U.S. President Donald Trump didn’t merit a mention but his shadow loomed. Mr. Li cited the challenge posed by deglobalization, protectionism and “uncertainties” about the direction of other major economies. Beijing’s recipe, he says, is to push ahead with regional trade agreements. Infrastructure at home features prominently, with $377 billion earmarked for railways, highways and waterways this year. Mr. Trump has yet to make good on his campaign pledge for a $1 trillion infrastructure binge.

* * *

The key announcement was that, as reported previously by Reuters, China has cut its growth target this year to “around 6.5% or higher if possible in practice” as the world’s second-largest economy continues to push through painful reforms to address a rapid build-up in debt, while erecting a “firewall” against financial risks. The new GDP target, the lowest in decades, was “realistic and would help steer and steady expectations”, said Li. Last year China set a target of 6.5%-7% last year, ultimately achieving 6.7% growth, supported by a record surge in bank loans, a speculative housing boom and billions in government investment.

Cited by Reuters, Huang Shouhong, director of the State Council Research Office, who helped craft the premier’s work report said growth of around 6.5 percent is sufficient to safeguard employment. China added 13.14 million new urban jobs in 2016, with the number of college graduates finding employment or starting businesses reaching another record, according to Li’s report. “As for whether there is a bottom line on growth, as long as there are no problems in employment, growth slightly higher or lower is acceptable,” Huang said.

Despite the modest decline in growth forecasts, some were still stunned by the proposed bogey. Michael Tien, a Hong Kong delegate to China’s parliament and founder of clothing chain G2000, said he was surprised by the 6.5% figure. “I think it’s very high,” he told Reuters. “In the past few years, whatever number they come up with, they will always meet it, and they will always exceed it a little bit. So with this economy, 6.5 (percent) is mind-boggling.”

As part of its growth, China hopes to keep CPI growth in the “golden range” of 2-3%, a target which may prove difficult to attain in light of the recent commodity-price driven surge in wholesale inflation which is now spilling over into consumer prices. The goal may be problematic after the PBOC said it will not pursue an overly tight monetary policy.

In an attempt to cool inflation, the government is moving to cool the housing market, slow new credit and tighten its purse strings. As a result, China – as it has attempted on various previous years – will have to depend more on domestic consumption and private investment for growth. As in the previous year, China did not set a target for exports, underlining the uncertain global outlook. “The developments both in and outside of China require that we are ready to face more complicated and graver situations,” Li said, adding that world growth remained sluggish, while deglobalisation and protectionism were gathering pace.  Li also said that China will continue its aggressive investment, planning to allocated 800 billion yuan to railway construction, and 1.8 trilion yuan in highway and waterway projects.

To be sure, a core challenge facing China will be the trade off between debt expansion – which according to the IIF is already at 300% of GDP with conventional estimates holding slighly lower numbers – and growth. According to economists is will be a delicate balancing act to support growth and maintain liquidity while pursuing reforms and taming unruly financial forces.

Just like GDP, the 2017 target for broad money supply growth was also cut slightly to around 12% from about 13% for 2016. The government’s budget deficit target was kept unchanged at 3 percent of GDP.

Li said China would continue to implement a proactive fiscal policy, adding that government aimed to cut companies’ tax burden by about 350 billion yuan ($51 billion) this year. China will also maintain a prudent and neutral monetary policy, he said.

Financial Firewall

In yet another attempt to deleverage, something China has engaged in on various occasions in the past several years and failed, Beijing has flagged in recent months a gradual shift away from a loose monetary stance to discourage speculative investments. Since February, the central bank has raised by tiny increments the interest rates on some lending facilities. Jia Kang, former director at the finance ministry’s Institute of Fiscal Science, told Reuters he did not expect the PBOC to hike policy rates, at least in the near term. “It seems unlikely, since stability comes first in the short term,” Jia said.

At present, systemic risks are under control, but China must be fully alert and build a “firewall” against financial risks, Li said. Chinese banks extended a record 12.65 trillion yuan of loans in 2016, and recent data shows that new yuan loans hit 2.03 trillion yuan in January, the second-highest ever. “We will apply a full range of monetary policy instruments, maintain basic stability in liquidity, see that market interest rates remain at an appropriate level, and improve the transmission mechanism of monetary policy,” Li said. China will also press on with asset securitisation and debt-to-equity swaps this year.

Jobs and Overcapacity

China aims to create more than 11 million new urban jobs this year, while keeping the registered urban unemployment rate at 4.5% or below, even as employment pressure grows. China also plans to reduce the number of rural residents living in poverty by over 10 million, including 3.4 million to be relocated from inhospitable areas.

As Reuters further adds, China will push forward with reform of state-owned firms and assets this year according to Li said. Ownership reforms at more than 100 central government-run enterprises will be completed by year-end as part of efforts to use private capital to revive its lumbering state sector, state media reported last month. China is also looking to shutter more ‘zombie’ enterprises, a term loosely used to describe inefficient firms with surplus capacity. The National Development and Reform Commission (NDRC) said in a work report released on Sunday that it would shut or stop construction of coal-fired power plants with capacity of more than 50 million kilowatts.

China will also cut steel capacity and coal output this year, the economic planner said. Li said that China plans to reduce steel production capacity by 50 million metric tons while shutting down at least 150 million metric tons of coal production facilities. As a result, fixed-asset investment – traditionally the biggest source of China’s growth – is expected to rise about 9 percent in 2017, down from last year’s target of 10.5 percent. “As overcapacity is cut, we must provide assistance to laid-off workers,” Li said.

* * *

How successful China will be in its ongoing transformation to a consumer-driven economy remains to be seen: in previous years, China has fallen short of its goal, traditionally falling back on debt expansion to plug the gaps. This time will likely not be any different.

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