This weekend saw the annual Central Economic Work Conference, during which the government analyzes the current year’s data with a view to setting the tone for the following year’s economic policy. I asked Alistair Thornton, China Analyst at IHS Global Insight, for his take on some of the key issues that came up.
China’s inflation rose to a 28-month high of 5.1 percent in November. How much of a concern should this be for policymakers?
Inflation is shaping up to be the most crucial macro issue for 2011. Liquidity is not going to be aggressively reeled-in next year, and as such, a lot of upward pressure will remain on asset markets and consumer prices. Thus far, policymakers have sought to control the extremes through administrative measures and monetary policy tinkering, rather than broad-based measures that could have an impact on the wider economy. In short, inflation—in one form or another—is here to stay in China, and policymakers will have to adapt to this new and more volatile economic environment in setting policy going forward.
One of the issues in China that comes up periodically is overcapacity—the empty city, for example, or empty apartment rates. Is there any danger that if China moves to bring inflation down, then this could lead to aggregate demand falling, thus exacerbating the overcapacity problem?
Not really. Overcapacity is a perennial problem, but it is a by-product of China’s turbo-investment growth model. Policymakers are seeking to set the economy on a more sustainable path, focusing on the quality not quantity of growth—they’re looking to reduce the excesses in over-capacity, rather than over-capacity in general. Investment spending will remain strong for some time to come, and provides deflationary pressure in the form of overinvestment. If, in tackling inflation, they over-cook the policy response, then overcapacity will be the least of their worries.
Was there anything particularly interesting or surprising to come out of the Conference?
There was nothing particularly surprising that came out of the Work Conference, given that it came on the heels of the drafting of the Five-Year Plan. We have a fairly good understanding of the direction that policymakers wish to take the economy, and movement towards this is present in both the statement from the Conference and the FYP. The government pledged to ensure a ‘healthy and stable’ economy. Reading into this…
I think ‘stable’ is a reference to the shift in monetary policy, with inflation becoming policymakers’ top priority over the next year. With liquidity unlikely to be aggressively reeled-in for 2011, there will remain strong upward pressure in the property market and consumer prices. With a strong historical correlation in China between high inflation and societal unrest, policymakers will be looking to settle inflation expectations and remedy the most socially-harmful aspects of rising prices, such as food prices (which hurt the poor the most). Policymakers are trying to push on in their stimulus cycle exit, bringing the economy down smoothly into a soft landing, whilst avoiding any volatility that might come with slower growth and rising inflation.
In terms of ‘healthy’, I think this is a reference to the longer-term structural adjustment that they are seeking to enact. It’s becoming increasingly obvious that China cannot sustain its current economic model, relying too much on investment and external demand. It needs to refocus its growth engines towards domestic consumption. This is reflected in measures in the Five-Year Plan that seek to boost income growth—which, in turn, feeds into stronger consumption—and the recognition that headline growth needs to slow, and a higher rate of inflation needs to be accepted. A slower economy can be more easily retooled towards bolstering domestic consumption and trimming the excesses in investment and export dependency that accompanies current growth.
After the meeting, Xinhua report that participants had agreed ‘China's stable economic development would encounter a complicated situation next year, with many challenges and difficulties’. Are there any concerns you have about the economy that perhaps haven’t received much attention yet?
For me, the primary short-term downside risk flows from excessive liquidity. Strong liquidity has ensured that, over the next year, headline growth is secured. Meanwhile, the government has a wide range of policy tools to tackle inflation and any phenomenon that occur. However, the crucial point is that these tools aren’t free—they each come with a cost. When the government, in a couple of years, has to unravel the more negative ramifications of the liquidity-fuelled boom, they will be faced with a lot of ugly choices.
It's been reported that China’s targets for 2011 include 4 percent inflation and 8 percent GDP growth. What do you make of those figures?
An inflation target of 4 percent reflects the realisation that inflationary pressures aren’t going to recede as long as excess liquidity remains. Given they don’t want to jeopardize the broader economy, a relatively high bank lending target has been set, and inflation is just one of the inevitable side-products. There’s no point trying to pretend that inflation is going to remain at the abnormally low levels China has seen through the past 30 years. The growth target should be lower than what we have seen over the past decade, given that policymakers’ rhetoric points to a ‘quality not quantity’ story, with an acceptance of lower growth in order to achieve a more sustainable model, and one that provides just the same, if not more, job creation.