MK Tang: China’s Reforms Are Unfinished Business

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MK Tang: China’s Reforms Are Unfinished Business

But meaningful progress has been made in cushioning an economic downturn.

MK Tang: China’s Reforms Are Unfinished Business
Credit: Goldman Sachs

China’s growth continues its descent this quarter, causing concerns about the implications for the country’s trading partners and the global economy in general. On the bright side, growth is expected to stabilize next quarter and tick up slightly after that, thanks to stimulus measures taking effect.

That’s according to Man-Keung Tang, a managing director and chief China economist at Goldman Sachs. He adds that interest rate cuts would remain the primary policy tool of the People’s Bank of China (PBOC) in case the slowdown worsens. In this interview, he reviews backstops against a potentially more serious decline.

Maurits Elen: How does China’s growth story fit within that of Asia?

MK Tang: We expect China’s GDP growth to ease to 6.2 percent in 2019, down from 6.6 percent last year. Exports look set to slow, given moderating U.S. and euro area growth as well as potential paybacks to the export frontloading late last year. Domestic private spending, including corporate investment and household consumption, also faces headwinds from tight credit conditions and softer confidence. On the other hand, the government will likely introduce further stimulus, especially on the fiscal front, with support for infrastructure investment being a key policy priority.

In most of the rest of Asia, growth will also likely slow this year, largely reflecting the less favorable global backdrop including more anemic Chinese growth. In addition, a few countries in the region have been on an interest rate hiking cycle, which has also weighed on domestic demand.

To what extent will China weigh on global growth?

We have already seen material impact of China’s slowdown on the exports of some Asian countries. Over the next few months, we think the Chinese economy will probably slow a bit more, which will continue to impinge on the world economy. However, we expect China’s growth to stabilize in the second quarter (Q2) and pick up slightly in the second half of the year (H2), on the back of domestic policy support. In particular, stronger infrastructure growth in China should bring relief to some commodity-producing countries.

Is a global recession in the making?

We do not expect a global recession this year. While the world’s biggest economy, the U.S., is expected to decelerate, the relatively contained financial risks among American households and corporates at present should keep the U.S. economy from contracting. Meanwhile, many emerging market countries’ external imbalances have improved in the last few years, making their economies more resilient.

What lies ahead for China’s reform program?

As China transforms into a more market-based and liberalized economy, tensions are bound to arise. Just as the economic optimism in 2017 and early 2018 was partly inflated by short-term tailwinds such as a strong rebound in external demand, the challenges faced by the economy at this point have been exaggerated by cyclical pressures and partly reflect the earlier policy tightening to rein in financial risks. If we step back a little and focus on the structural development, the government has made meaningful progress in recent years that helps cushion an economic downturn. These include curbs of sectors with overcapacity, promotion of the more stable service sector, and a higher flexibility of the exchange rate.

So far, the policy easing has been more measured than in the previous episodes of a slowdown. This also indicates that in balancing short-term growth against longer-term sustainability, the government has shifted more in favor of the latter.

That said, there is no doubt that economic reforms in China are unfinished business. Important tasks ahead include strengthening the social safety net to encourage consumption, more effectively resolving zombie enterprises, and reducing implicit guarantees, just to name a few.

Monetary policy is focused on reserve requirement ratio (RRR) cuts, the medium-term lending facility (MLF), and issuance of perpetual bonds. How does the latter compare to quantitative easing (QE)?

The PBOC has set up a program to allow primary dealers’ holdings of perpetual bonds to be swapped to central bank bills. This will bolster the liquidity of perpetual bonds and increase their appeal to investors. Issuance of perpetual bonds can help raise the banking system’s (additional tier 1) capital level, thereby strengthening the ability of banks to withstand shocks and to lend.

However, the bill swap program does not involve the PBOC creating additional base money or taking on the credit risk of the perpetual bonds. Therefore, it would be a stretch to call the program QE.

If growth starts ebbing faster than expected, what last resort measures do you expect the PBOC to start rolling out to support growth?

As money market interest rates are significantly above zero, there is still much scope for the PBOC to conduct easing through the conventional channel of lowering rates. Moreover, monetary policy transmission through the financial markets — notably the bond market — seems to continue to work well. Long-dated yields still tend to fall and corporate bond issuance to pick up on any major dovish PBOC signals. The case for QE as a policy option would be stronger should money market rates come closer to the zero bound.

If growth slows by more than expected, we think reductions in interest rates would remain the PBOC’s primary policy tool for the time being. More targeted financial support, such as for small private enterprises, could also be ramped up further to ease strains for underserved sectors.

This interview has been edited for clarity.