The new normal Chinese economy: Reduced economic stimulus for sustained growth

By Suranjana Roy 

The Keynesian economic theory states that the aim of economic stimulus packages is to increase investments in an economy, as investment multipliers work, such a package increases income more than the investment injected. Therefore, such packages are utilized by a monetary authority, like the Central Bank, as an expansive monetary policy, inducing economic growth. But there is a pertinent question related to this: Is this observed growth necessarily sound and sustainable?

Recent developments in the Chinese economy serve as an insight into this question.The Governor of People’s Bank of China, Zhou Xiaochuan, has declared that the Chinese economy will significantly reduce its dependence economic stimulus, as a measure to battle the economic risks it has been facing and to ensure a boost in the economy. He added that China will be more cautious about the spending this year, in order to curb the rapid build-up in debt.

A bleak future?

Major countries who got affected by the 2008 financial meltdown, introduced economic stimulus packages to increase credit and investment, hence seeking to restore economic growth. While the United States did it too, the effects of the same where observed radically more in China, which undertook immensely larger package worth 4 trillion Yuan. This accounted for 12 percent of the GDP in 2008, and 30 percent of the overall program was to be funded by the central government while the rest would be shared among local governments. However, in reality, the central government ended up spending a total of 1.6 trillion Yuan worth of stimulus more than what was planned.

Companies grew exponentially since 2010, their spending accounted for roughly 10 percent of GDP each year, with an increasing share used for what are essentially commercial projects. The share of GDP that came from investment rose to above 50 percent, reaching a new threshold in the recent economic history. However, this stimulus package was highly criticized: It ended up lending massive amounts to local governments, primarily for infrastructure development which has low returns. It also caused a surge in the Chinese debt, as it went ahead with its spending spree. This made its growth sap. A Credit rating agency, Moody’s Investors Service, said that the steady buildup of debt would erode China’s financial strength in the years ahead. It cut the country’s debt ratings, the first downgrade since the Tiananmen Square Crackdown.

China’s debt problem could be compared to that of Japan’s. After a long boom due to credit injections, Japan’s bubble of prosperity burst in the early 1990s with a deflationary pressure taking over the entire economy. The Japanese government is reluctant to deal with indebted companies, which also adds to its sluggish growth.

Reforms the Chinese economy the new normal

The fallout of the stimulus package has led to the PBOC initiate measures to curb the financial risks, and perhaps, a crisis. It allowed the interest rate at which banks lend to each other rise and carried out ‘supervisory tightening’ in its regulations. The Chinese authority is attempting to balance real economic activity and the increasing risks that a complex financial system entails. Even though total new loans have increased over the years, the recent slowdown in the financial activities is the reflection of PBOC’s regulations.

Critiques say it’s impossible to not depend on economic stimulus. China’s growth is intrinsically depended on credit. This slowdown of credit will eventually make the Chinese economic falter. This is at the time where its already subjected to trade wars, closing international markets imbued with protectionism. Analysts believe that an unstable economy would affect the massive imports and exports China undertakes, thus deteriorating the economic powerhouse it has been over the decades. Analysts at HSBC note that such regulations have been aimed at financial institutions, with reductions in the overall debt levels still being immensely risky to tackle without hampering GDP growth. “We believe the extent and complexity of the administrative fixes undertaken by policymakers is constantly underestimated by both the media and the investment community. (However) structural reforms that fundamentally resolve the debt overhang are still urgently needed,” HSBC said in a recent report.

Zhou, however, said, that their “de-risking” and “deleveraging” campaign is working as reflected in the moderation of China’s M2 measure of money supply. “Everybody should see that China has entered a stabilizing leverage and is gradually reducing the leverage situation. The trends are clear,” said Zhou, referring to high debt ratios. The PBOC said that M2 growth was 8.8 percent on-year in February, higher than January’s 8.6 percent growth but down from 11.1 percent in the year-ago period.

Recent data add to Zhou’s statements, there isn’t a mechanical relationship between credit and growth. Even the loan has been reduced in the economy, the Chinese nominal GDP growth has accelerated. With slowing credit and quickening growth, there are notable effects on China’s Debt Ratios. A significant fall in the ‘Total Social Financing,’ the official measure of broad credit, is also expected to decline, given the data.

The US effect on China’s exports

Since the election of President Donald Trump, China has found itself in, what might be called, a wave of a trade war. The US is determined to return to its economic prosperity, and China is its major threat. Given the US proposition to levy heavy tariffs on imports, Chinese firms are already facing a rough future. The tumultuous environment in the International sphere demands China to fight back, as put by a hardline Chinese publication ‘Global Times’. But this would only be possible if the economy reaped benefits by relying less on economic stimulus. It’s only a matter of time when we will know what the fate of China is.