China should slow growth to prevent a “web of vulnerabilities” crippling its economy, while Japan needs its “third arrow” structural reforms firing faster. The contrasting assessments from the International Monetary Fund have put Beijing and Tokyo on notice amid rising political tensions between Asia’s economic heavyweights.
On Wednesday, the Washington-based organization warned in its latest annual assessment of China’s economy that a gross domestic product (GDP) growth rate as low as 6.5 percent should be targeted for 2015, with even this modest target requiring substantial reform.
After a decade of double-digit growth rates, China is expected to see GDP growth slow to 7.4 percent in 2014 and 7.1 percent next year, according to the latest IMF forecasts, with growing concern over its shadow banking sector and potential for a housing market crash.
Pointing to China’s vulnerabilities across key sectors of its economy, the IMF said the risk of “disorderly adjustment” would continue to rise, should Beijing keep relying upon a cocktail of credit and investment to fuel growth.
“Banks and shadow banks are exposed to real estate directly through credit to developers and household mortgages, and indirectly through the use of real estate as collateral for other loans. Local government spending is also linked to the real estate sector, directly through land sales revenue and indirectly through the tax revenue generated by real estate related activity,” the fund said.
“Given these interconnections, a major shock to any part of the web would reverberate throughout the whole, creating a negative feedback loop that could considerably amplify the original shock.”
According to the IMF, real estate accounted for up to a third of economic value-added in 2013, but oversupply in both residential and commercial markets is now dampening prices and threatening a correction. Corporate debt has risen by 10 percentage points since 2007 to reach 35 percent of GDP, with half of the increase relating to real estate and construction.
The Diplomat’s Sara Hsu has noted the pending “fiscal crisis” faced by Chinese local governments, along with “gargantuan” corporate debt amounting to $14.2 trillion at the end of 2013, exceeding the $13.1 trillion owed by U.S. corporations. According to Hsu, up to 30 percent of Chinese corporate debt is owed to the shadow banking sector, with “low to no transparency.”
The IMF also warned of the risk of an external shock, such as potential financial market volatility as advanced economies exit from ultra-low monetary policy, or from a protracted period of weaker growth reducing export demand.
“While an abrupt adjustment in the near term is unlikely, given China’s policy buffers, repeated use of this growth strategy would further weaken balance sheets, reduce investment efficiency, and leave China more vulnerable to shocks in the future,” the IMF said.
The fund called for Beijing’s accommodative policies to be unwound and further reforms enacted to ensure the transition to a “new growth model,” including reforms to state-owned enterprises and the financial sector along with tax and social security.
It said such reforms offered “somewhat slower but safer growth in the near term, with the significant long-run benefit of securing more inclusive, environment-friendly, and sustainable growth” and higher income and consumption per capita.
According to the Australian Financial Review’s Greg Earl, slowing growth in China has come amid an escalating political battle over a corruption crackdown launched by Chinese President Xi Jinping. An estimated 33 government or state government officials of deputy provincial leader status have been purged since Xi’s accession to the presidency, as well as former top security official Zhou Yongkang, as part of a push seen cementing Xi’s power.
Territorial disputes with neighboring Japan, Asia’s second-biggest economy behind China, have encouraged a shift by Japanese companies toward investing more in Southeast Asia and less in China. According to JETRO data, Japanese investment in China dropped by a third in 2013 compared to a 21 percent rise for Asia, including a 70 percent increase in the Philippines.
Total foreign direct investment in China dropped by around 7 percent in May, amid reported concerns by foreign investors of rising labor costs and arbitrary law enforcement, the Wall Street Journal said.
Japan’s ‘Abenomics’ Still Firing
Despite concerns over the effects of April’s consumption tax hike in Japan, the IMF said Thursday that “Abenomics” was still on track, although it urged further structural reform to ensure a sustained recovery.
“We expect Japan’s economy to grow by about 1.6 percent this year, before slowing to 1.1 percent in 2015 as a result of fiscal adjustment,” Jerry Schiff, deputy director in the IMF’s Asia and Pacific Department, said in a statement.
“Inflation is expected to rise temporarily to 2.8 percent on average for 2014 due to recent increase in consumption tax rate, and we expect the Bank of Japan’s 2 percent target will be achieved over the medium term.
The fund’s annual assessment noted that Japanese Prime Minister Shinzo Abe’s first two arrows of expansionary fiscal and monetary policy had spurred growth, but “progress across the three arrows has been uneven and medium-term risks remain substantial”.
“Inflation has risen, a consumption tax increase has been implemented, and there are signs of a transition to private-led growth. However, structural reforms have progressed slowly and a medium-term fiscal plan beyond 2015 is still to be articulated. Uncertainty is therefore high whether the recovery and exit from deflation will become self-sustained under current policies,” the report said.
The fund urged “more forceful” growth reforms to overcome structural headwinds, with recent gains relying mainly on fiscal and monetary stimulus.
“We recommend in particular, raising the employment of women, older workers, and foreign labor, which would help to offset the aging-related decline in the labor force,” Schiff said. “At the same time, deregulating agriculture and domestic services sectors, as well as reforming corporate governance, would help raise productivity and encourage investment.”
While the IMF said monetary policy remained “appropriately accommodative,” it said further fiscal reform, including another consumption tax hike in 2015, would be “critical to establish a track record of fiscal discipline.”
“For Abenomics to succeed, reforms need to be comprehensive and sustained for an extended period. This would help secure the new inflation target and generate powerful synergies to overcome structural headwinds from a shrinking labor force and a large fiscal adjustment need,” the report said.
The mixed reading on Abenomics has come amid faltering poll figures for the Abe Cabinet, which has seen support fall to its lowest level since coming to office. While still high compared to his predecessors, the drop has been blamed on the consumption tax hike as well as Abe’s defense stance, which is seen countering China’s territorial ambitions.
Amid China’s rise and Japan’s attempted revival, “speeding up” is exactly the desired goal sought by Abe in his second term as prime minister. For Beijing though, slowing down is unlikely to be welcomed by a leadership keenly aware of the growing threats to its longevity.