As China’s Economy Stumbles, Government Eyes Reform

Another week, another set of weak economic data out of China. Fixed-asset investment slowed, industrial production grew less than projected and while retail sales growth met expectations it was driven almost entirely by a 72.2 percent increase in jewelry purchases, apparently by consumers taking advantage of the drop in gold prices.

As Capital Economics concluded in a note about Monday’s data:

The upshot is that today’s figures are not encouraging for anyone hoping for signs of an economic rebound. There is probably less to the pickup in industrial output growth than first appears. Investment is slowing. Retail sales, the relative bright spot, are simply holding their ground. Our position remains as before: as long as there is little sign of problems in the labor market, weak growth numbers on their own will not prompt policymakers into substantial further policy loosening

Monetary policy in China is far from tight. According to data released on Friday, China’s total social financing for April was 1.75 trillion yuan, ahead of the median estimate of 1.5 trillion yuan. Perhaps this loan activity will translate into more growth going forward, or perhaps it is just barely keeping gross domestic product growth above the official target of 7.5 percent.

Xinhua, China’s state news agency, declared that the April data shows policymakers are reinforcing prudent monetary policy. April M2 growth was 16.1 percent, once again ahead of the government’s 2013 overall M2 growth target of 13 percent. Either M2 growth will have to slow dramatically later in 2013 or the government will exceed its annual target.

Last week China reported surprisingly strong import growth for the January-April period, but good luck finding anyone who actually believes that data. A Chinese newspaper calculated that companies, using fake invoices and other tricks, brought in $58 billion of “hot money.”

How times change. Just a few months ago analysts were worried about capital outflows, but now money is pouring back in and forcing up the value of the yuan. The underlying economic fundamentals would not seem to support such bullishness. Perhaps the relative political certainty that has returned with the Xi administration’s consolidation of power, along with Abenomics and the devaluation of the Japanese yen, have renewed the appetite for the yuan.

Whatever is driving the inflow, Chinese state media is signaling that additional appreciation of the currency is not desirable. Sunday’s Global Times quoted “experts and insiders” as saying that the “Chinese yuan has limited room to appreciate further and may be depreciated to foster the country’s struggling exports and the broader economy.”

URBANIZATION AND COMPREHENSIVE ECONOMIC REFORM are among the main hopes for supporting and improving the quality of China’s growth, as well as for commodity producers and investors globally. The urbanization bill will be huge: Researchers at the Chinese Academy of Governance have just released a report estimating the costs at over 1.8 trillion yuan.

Urbanization is near the top of the agenda for the government but there is still much debate about the details of what urbanization really means and how it will be implemented. First Financial, a leading Chinese newspaper, reported on Monday that a national urbanization conference originally expected this month has been delayed, apparently because the top leadership was unhappy with the draft. Top-level pressure could be good news for those hoping for an aggressive urbanization program, but it could also be a sign of bureaucratic paralysis and infighting over a massively complex initiative that touches on many powerful interests.

The government continues to state that it is pushing forward with significant reform. Australian journalist John Garnaut, one of the top foreign reporters in China, reported Monday that “China is drawing up a blueprint for sweeping reforms aimed at averting an economic crisis” that would be delivered to the Third Plenum of the 18th Party Congress, expected to meet in October. Third Plenums have a special place in Chinese history; the December 1978 Third Plenum of the 11th Party Congress kicked off the “reform and opening up” policy.

The next phase of reform will likely be much more complicated and painful than the program Deng Xiaoping set in motion, and assuming it moves forward we should expect it to be messy and fitful at times. Too much hope may be placed on the upcoming Third Plenum, but there is still reason for optimism about the prospects for much deeper economic reforms.

The main reason I remain optimistic is that the leadership, and especially Xi Jinping, seem very clear that without more reform there will be no fulfilling the “Chinese dream.”