EVENT­FUL 2013

China Daily’s year-en­der series be­gins with the econ­omy

China Daily (Hong Kong) - - FRONT PAGE -

What do you think will be the most fa­vor­able and un­fa­vor­able do­mes­tic fac­tors for the Chi­nese econ­omy in 2014?

China’s econ­omy is on track to start 2014 on a pos­i­tive note. Since mid2013, growth has picked up as ex­ports re­cov­ered amid im­prov­ing global de­mand.

Do­mes­tic de­mand growth has held up fairly well all along, with the Novem­ber data sug­gest­ing slower in­vest­ment growth and faster con­sump­tion growth.

The cur­rent pace and pat­tern of growth are set­ting the stage for 2014. We ex­pect China to con­tinue to ben­e­fit from bet­ter global de­mand. Do­mes­ti­cally, the key fac­tors are the im­pact of firmer mone­tary pol­icy and struc­tural re­forms on growth.

Weigh­ing up the key fac­tors, with the above-men­tioned de­mand trends broadly con­tin­u­ing, we ex­pect solid growth of 8.2 per­cent in 2014 — which di­verges from con­sen­sus pro­jec­tions — while be­ing cog­nizant of the risks.

A key ques­tion is the im­pact of struc­tural re­forms on growth. The “doc­u­ment on ma­jor is­sues con­cern­ing com­pre­hen­sive and far-reach­ing re­forms”, re­leased af­ter the Third Plenum of the Party’s Cen­tral Com­mit­tee, is a brief to move ahead with a sys­tem­atic and com­pre­hen­sive pro­gram of eco­nomic and so­cial re­form.

The pace of im­ple­men­ta­tion is likely to be fairly grad­ual; we do not think that is re­ally a prob­lem as long as re­form con­tin­ues. But what about the im­pact on growth in 2014? We think the struc­tural re­forms that are likely to be at least partly im­ple­mented in 2014 will, on bal­ance, be neu­tral or mildly pos­i­tive for growth. Likely mea­sures with a pos­i­tive im­pact on growth in­clude re­mov­ing bar­ri­ers for pri­vate cap­i­tal, sim­pli­fy­ing pro­ce­dures, lib­er­al­iz­ing and de­vel­op­ing the fi­nan­cial sec­tor and par­tially open­ing the cap­i­tal ac­count.

Their im­pact should out­weigh the ef­fect of re­forms that could dampen growth, such as charging higher State-owned en­ter­prise div­i­dends and chan­nel­ing the rev­enues to the Min­istry of Fi­nance, prop­erty tax­a­tion, higher prices and/or taxes for raw re­sources and a change in the weight­ing in the per­for­mance eval­u­a­tion of se­nior lo­cal govern­ment of­fi­cials.

Pol­i­cy­mak­ers are im­ple­ment­ing a firmer mone­tary stance in or­der to rein in credit growth and fi­nan­cial risk. The firmer stance is ev­i­denced by the de­cel­er­a­tion of fi­nan­cial ag­gre­gates and higher in­ter­est rates on the in­ter­bank mar­ket.

Even as pol­i­cy­mak­ers tighten up on banks’ use of in­ter­bank fi­nanc­ing and “shadow bank­ing”, we ex­pect they will aim to main­tain solid ex­pan­sion of core bank lend­ing, in­clud­ing by pos­si­bly eas­ing up on banks’ lend­ing quo­tas.

Such a pat­tern should limit the im­pact of tighter mone­tary pol­icy on eco­nomic growth, as in 2011, when the govern­ment clamped down on “shadow bank­ing” with­out caus­ing an ob­vi­ous eco­nomic slow­down.

But a larger neg­a­tive sur­prise would likely lead the govern­ment to com­pro­mise on the firmer pol­icy stance. We see two main sources of risks in our growth out­look for 2014: Weaker global de­mand would mean lower ex­port growth and cor­po­rate in­vest­ment. Do­mes­ti­cally, the im­pact of a tighter mone­tary stance on growth could be larger than we ex­pect. Also, amid changes in the con­duct of mone­tary pol­icy, hic­cups and un­ex­pected out­comes are pos­si­ble.

The Chi­nese econ­omy will re­main in a pe­riod of im­por­tant strate­gic op­por­tu­ni­ties in 2014. As stable eco­nomic progress is ex­pected to con­tinue, GDP growth of 7.5 per­cent is pos­si­ble in 2014, which puts it in a rea­son­able range.

A key theme of next year’s eco­nomic de­vel­op­ment is that the cen­tral govern­ment will fo­cus on deep­en­ing re­form and open­ing-up and fur­ther pur­sue struc­tural re­bal­anc­ing and in­dus­trial up­grad­ing fol­low­ing the di­rec­tives of the Third Plenum of the 18th Cen­tral Com­mit­tee of the Com­mu­nist Party of China.

Pos­i­tive fac­tors to sup­port growth mo­men­tum are in­creas­ing. One of the most im­por­tant is that China’s ur­ban­iza­tion is en­ter­ing a new stage of rapid de­vel­op­ment. With the stim­u­lus of re­form, ur­ban­iza­tion is ex­pected to ac­cel­er­ate in 2014.

Many ru­ral mi­grant work­ers may start new lives in cities as “new cit­i­zens” — to en­joy ur­ban res­i­dents’ so­cial in­sur­ance, ed­u­ca­tion and em­ploy­ment op­por­tu­ni­ties. The change in their sta­tus will ex­pand the con­sumer mar­ket.

The ser­vices in­dus­try will be ac­cel­er­ated to a faster pace — a sce­nario that pol­i­cy­mak­ers hope to see dur­ing the growth-pat­tern trans­ac­tion.

In 2014, de­mand for fi­nan­cial, ed­u­ca­tional and health­care ser­vices will ex­pand faster. On­line shop­ping will con­tinue to grow rapidly.

The in­crease of do­mes­tic con­sump­tion may partly off­set slower fixed-as­set in­vest­ment and help main­tain stable over­all eco­nomic growth.

One of the down­side risks of con­cern for next year is that in­dus­try will face more dif­fi­cul­ties.

The of­fi­cial fig­ures show that in the third quar­ter of this year, in­dus­trial com­pa­nies’ rev­enues and prof­its im­proved, com­pared with the first half. But ris­ing pro­duc­tion costs, de­clin­ing whole­sale prices and tight credit are hold­ing them back. As these dif­fi­cul­ties may fur­ther weaken busi­ness con­fi­dence, they may pre­fer to cut out­put and in­vest­ment.

Also, the govern­ment has de­cided to keep credit growth “at a rea­son­able pace” to pre­vent fi­nan­cial risks. Thus, a rel­a­tively tight fi­nan­cial en­vi­ron­ment is likely in 2014, which may slow in­dus­trial in­vest­ment.

How will China’s eco­nomic slow­down af­fect for­eign en­ter­prises’ in­vest­ment in the na­tion, and how can they adapt to that change? How will the slow­down af­fect the global econ­omy?

While we ex­pect China’s eco­nomic growth to slow to 7 to 8 per­cent next year and then fur­ther to 6 to 7 per­cent in the fol­low­ing five years, we want to high­light the pos­i­tives of the slow­down.

First, the ab­so­lute in­cre­ment in China’s GDP will still be more than $900 bil­lion a year (as­sum­ing an av­er­age 3 to 3.5 per­cent in­fla­tion rate). That amount will be big­ger than 10 years ago, when China’s nom­i­nal GDP was grow­ing at 17 to 18 per­cent a year. China’s con­tri­bu­tion to global GDP growth will still likely be the largest in the world.

Sec­ond, slower but more bal­anced and sus­tain­able growth that is less re­liant on in­vest­ment is also a pos­i­tive for the world econ­omy.

For the global econ­omy, the im­pact of China’s slow­down de­pends on its cause. If it is due to a weak global econ­omy and weak ex­ports, the im­pact will be less. If the slow­down is caused by slower do­mes­tic de­mand, es­pe­cially in­vest­ment de­mand, then the im­pact on some coun­tries will be much more no­tice­able.

Slower growth of in­vest­ment in China means weaker de­mand for com­modi­ties and ma­te­ri­als, as well as in­vest­ment goods. So the coun­tries that will be af­fected most will be the com­mod­ity-ex­port­ing coun­tries, par­tic­u­larly ex­porters of me­tals and coal.

How­ever, China’s de­mand for con­sumer goods and ser­vices will likely con­tinue to grow strongly, ben­e­fit­ing coun­tries that are ex­porters of such goods and ser­vices.

China will also likely go through some struc­tural shifts in its ex­ports. As the coun­try be­comes less com­pet­i­tive in lower-end, la­bor-in­ten­sive prod­ucts and moves up the value chain in ex­ports, there will be in­creased op­por­tu­ni­ties for low-cost coun­tries such as Viet­nam, Bangladesh and Pakistan. Mean­while, China may start to com­pete more with coun­tries that ex­port mid­dle-range prod­ucts.

For for­eign com­pa­nies in­vest­ing in China, there may be a grad­ual shift away from in­vest­ing in la­bor-in­ten­sive ex­port sec­tors. Mean­while, China’s do­mes­tic mar­ket will con­tinue ex­pand­ing at a fast pace of more than $900 bil­lion a year, which of­fers great in­vest­ment op­por­tu­ni­ties.

There­fore, we fore­see that for­eign in­vest­ment in China will in­creas­ingly fo­cus on goods and ser­vices that sat­isfy China’s own needs. A good ex­am­ple is a re­cent an­nounce­ment by Daim­ler Co, the Ger­man au­tomaker, which said it will lo­cate the com­pany’s first and only en­gine fac­tory out­side of Ger­many in China.

For­eign com­pa­nies can no longer ex­pect China’s de­mand for ma­te­ri­als and com­modi­ties to grow at the pre­vi­ous fast pace. Also, they should see the Chi­nese mar­ket it­self as the main rea­son for in­vest­ment in China, not ex­ports.

In the Chi­nese mar­ket, for­eign com­pa­nies may face tougher com­pe­ti­tion as they may not have the com­par­a­tive ad­van­tage they en­joyed in in­ter­na­tional mar­kets rel­a­tive to Chi­nese com­pa­nies.

For­eign com­pa­nies need to do re­search on China’s lo­cal mar­ket, which is big and di­verse, as well as be­ing very dif­fer­ent from the in­ter­na­tional mar­kets they are fa­mil­iar with.

For­eign com­pa­nies will also need to rely more on do­mes­tic tal­ent in China to help them to ex­pand in the lo­cal mar­kets.

The growth po­ten­tial in China’s tra­di­tional in­dus­tries and la­bor­in­ten­sive in­dus­tries, I be­lieve, is quite limited now. How­ever, for­eign in­vestors can still find lots of op­por­tu­nity in the high-tech sec­tor and in the ser­vice in­dus­tries, such as health­care, ed­u­ca­tion, cul­ture and le­gal ser­vices.

Though China’s eco­nomic growth may slow in the com­ing years, it will re­main one of the most at­trac­tive des­ti­na­tions for for­eign in­vestors, as the down­side risks in other emerg­ing economies are much higher.

Though the govern­ment hasn’t set a spe­cific eco­nomic growth tar­get for 2014, most econ­o­mists agree on growth of about 7 per­cent.

The eco­nomic slow­down is ac­tu­ally not a bad thing. It en­ables the govern­ment to ad­dress some thorny prob­lems. The re­form pack­age re­vealed af­ter the Third Plenum of the Com­mu­nist Party of China’s 18th Cen­tral Com­mit­tee clearly shows that the govern­ment is keen to ad­vance mar­ket-based re­forms to achieve qual­ity growth.

More­over, slower but steady growth in China means more for the global econ­omy, com­pared with volatile growth.

The bal­loon­ing bub­ble in the real es­tate sec­tor and the grow­ing un­cer­tain­ties sur­round­ing lo­cal govern­ment debt are the two ma­jor chal­lenges fac­ing China’s econ­omy.

If big prob­lems oc­cur in these two sec­tors, it will hurt de­vel­oped economies’ con­fi­dence in China. But, so far, the chance of that hap­pen­ing re­mains low.

What do you think will be the fa­vor­able and un­fa­vor­able in­ter­na­tional fac­tors for the Chi­nese econ­omy in 2014?

In China, the on­go­ing re­forms will broaden and deepen in 2014. Con­se­quently, fa­vor­able in­ter­na­tional forces for the Chi­nese econ­omy are those that sup­port these re­forms, and vice versa.

In the United States, the grad­ual ta­per­ing of the Fed’s quan­ti­ta­tive eas­ing pro­gram will strengthen the US re­cov­ery, thus sup­port­ing Chi­nese di­rect and port­fo­lio in­vest­ments in the US. Sim­i­larly, delever­ag­ing will not erode US con­sump­tion. In turn, an unan­tic­i­pated warm­ing of US-China re­la­tions could con­trib­ute to sig­nif­i­cant broad­en­ing and deep­en­ing of the bi­lat­eral Strate­gic and Eco­nomic Di­a­logue.

In Europe, a new con­sen­sus on the need for struc­tural re­forms and grad­ual im­prove­ment of eco­nomic prospects would sup­port Chi­nese trade and in­vest­ment in the re­gion, while pro­mot­ing Euro­pean in­vest­ment in China.

In East Asia, a warm­ing of China-Ja­pan re­la­tions would have pos­i­tive ef­fects on bi­lat­eral eco­nomic re­la­tions.

In the South China Sea, grad­ual re­duc­tion of po­lit­i­cal fric­tion would have the po­ten­tial to strengthen China-ASEAN re­la­tions. It could also boost sig­nif­i­cant de­vel­op­ments to­ward the “mar­itime Silk Road”, deeper re­gional in­te­gra­tion and China’s par­tic­i­pa­tion in vi­tal trade blocs.

Suc­cess­ful in­ter­na­tional man­age­ment of the Mid­dle East’s mul­ti­ple fric­tion points would in­crease the re­gional en­ergy sup­ply.

Global growth would re­bound on pol­icy ac­tions in ad­vanced economies, thus boost­ing de­mand for Chi­nese ex­ports and di­rect and port­fo­lio in­vest­ments world­wide, while sup­port­ing for­eign trade and multi­na­tional in­vest­ments in China.

In the US, the ta­per­ing of the QE pro­gram could start too early (or too late), thus caus­ing sig­nif­i­cant mar­ket volatil­ity and eco­nomic un­cer­tainty. Fur­ther, Wash­ing­ton’s bi­par­ti­san bud­get deal could un­ravel, which would cause mar­ket volatil­ity and eco­nomic stag­na­tion.

There could be an un­ex­pected chill in US-China re­la­tions, which would lead to ques­tions about the long-term fate of Chi­nese-owned US Trea­suries, Chi­nese in­vest­ment in the US and China’s dol­lar-de­nom­i­nated as­sets.

In­stead of progress, the Euro­pean sov­er­eign cri­sis could take an ad­verse turn, which would en­dan­ger Chi­nese trade and in­vest­ment in the re­gion, as well as Euro­pean in­vest­ment in China. It could also con­trib­ute to EUChina fric­tion and con­flict in trade, par­tic­u­larly high-tech trade.

There could be a dis­rup­tive de­te­ri­o­ra­tion in China-Ja­pan re­la­tions with a sub­stan­tial neg­a­tive feed­back ef­fect on bi­lat­eral eco­nomic re­la­tions.

An un­fore­seen clash could oc­cur in the South China Sea, which would cause bi­lat­eral or, even worse, mul­ti­lat­eral con­flicts with Ja­pan, the Philip­pines, Viet­nam and the US. It could en­dan­ger re­gional in­te­gra­tion and Chi­nese par­tic­i­pa­tion in crit­i­cal trade blocs.

Re­newed con­flicts in the Mid­dle East could en­dan­ger en­ergy sup­plies that are vi­tal to China’s con­tin­ued in­dus­tri­al­iza­tion and ur­ban­iza­tion.

Fi­nally, there could be sig­nif­i­cant ero­sion in global growth prospects, ei­ther due to deep­en­ing stag­na­tion in ad­vanced economies, to slow­ing growth in emerg­ing economies, or to both.

In an in­ter­na­tional con­text, the Chi­nese econ­omy faces mostly ad­verse fac­tors in 2014. The ma­jor threat is the ta­per­ing of the US Fed­eral Re­serve’s quan­ti­ta­tive eas­ing pro­gram, an­tic­i­pa­tion of which has al­ready spurred cur­rency slumps and in­ter­est rate in­creases.

The global econ­omy is re­bound­ing on a steady course, based on fore­casts by the In­ter­na­tional Mone­tary Fund and sev­eral lead­ing rat­ing agen­cies. The rel­a­tively quick re­bound, as op­posed to the fi­nan­cial cri­sis back in the 1930s, can be at­trib­uted to in­ter­de­pen­dent trade net­works. Or­ganic trade de­vel­op­ment has boosted the global re­cov­ery af­ter the eco­nomic down­turn.

De­vel­oped coun­tries are get­ting out of their eco­nomic nadir, and ro­bust signs of re­cov­ery are be­ing widely seen, no­tably in the United States. As a re­sult, the US is due to scale back its $85 bil­lion a month pro­gram of as­set pur­chases.

The­o­ret­i­cally, a badly ex­e­cuted pull­back may de­rail the Chi­nese econ­omy in the sense that a re­duc­tion in liq­uid­ity will raise in­ter­est rates and slow credit growth and in­vest­ment. More­over, con­cerns that tighter poli­cies may weaken growth are likely to tem­per hir­ing and dampen con­sump­tion.

How­ever, it is high time we delve into the rea­sons why China is es­pe­cially vul­ner­a­ble to the US’ loos­en­ing of its mea­sures, and re­think China’s cur­rent mone­tary pol­icy, which has been in place since the out­set of 2009.

Ma­ture mar­kets are ex­pected to grow at a pace of 2 per­cent year-onyear start­ing from 2014. For in­stance, the US has stim­u­lated its real econ­omy fol­low­ing US Pres­i­dent Barack Obama’s call to rein­vig­o­rate the man­u­fac­tur­ing sec­tor. In con­trast, the ex­pan­sion of de­vel­op­ing economies may shrink to just 1.43 per­cent.

If you look carefully into for­eign cap­i­tal flows, the ma­jor­ity of cap­i­tal in­flows into in­dus­trial economies are long-term in­vest­ments, while emerg­ing mar­kets — no­tably China — show the op­po­site pat­tern. Multi­na­tional cor­po­ra­tions are grad­u­ally re­lo­cat­ing from China back to ei­ther their home coun­tries or even to lower-cost na­tions. On the con­trary, the coun­try has con­sis­tently seen fresh spec­u­la­tive in­flows of money in the past two years. The coun­try’s for­eign-ex­change re­serves ex­panded at an un­prece­dented pace de­spite a dra­matic con­trac­tion in its ex­port fig­ures. These seem­ingly con­tro­ver­sial sta­tis­tics sug­gest that the for­eign-ex­change re­serve ex­pan­sion can only re­sult from the in­flux of “hot money” in­stead of long-term, more com­mit­ted in­vest­ment.

What do you ex­pect for China’s in­dus­trial de­vel­op­ment in 2014? How to ad­dress over­ca­pac­ity in the tra­di­tional in­dus­trial sec­tors? How to seize the op­por­tu­ni­ties cre­ated by new tech­nol­ogy?

New tech­nol­ogy should play a part in re­solv­ing the over­ca­pac­ity is­sue. Most of the idle ca­pac­ity is for low-end prod­ucts. Good-qual­ity prod­ucts are never hard to sell. The ideal way out would be to up­grade idle ca­pac­ity through in­no­va­tion and find mar­ket de­mand. But in­no­va­tion doesn’t hap­pen overnight, it hap­pens over time through im­proved ed­u­ca­tion and in­no­va­tion sys­tems.

In the short run, in­dus­trial con­sol­i­da­tion will help erase some of the idle ca­pac­ity. How­ever, con­sol­i­da­tion can’t be driven by ad­min­is­tra­tive mea­sures; it should re­sult from de­ci­sions made by the com­pa­nies in pur­suit of prof­itabil­ity.

Past ex­pe­ri­ence has proved that over­ca­pac­ity can’t be solved through govern­ment plan­ning. For in­stance, steel mills of­ten pre­tend to shut­ter un­nec­es­sary pro­duc­tion only to restart it later, while oth­ers have been se­cretly adding new ca­pac­ity as lo­cal govern­ments choose to look the other way out of con­cern for job cre­ation and rev­enue.

Bad loans and un­em­ploy­ment will be the two ma­jor is­sues if fac­to­ries are closed. But that shouldn’t be a rea­son not to pro­ceed.

Work­ers who lose their jobs should be cov­ered by so­cial se­cu­rity. And it is good to see that Bei­jing has been de­sign­ing mea­sures to mend the na­tion’s so­cial se­cu­rity net­work.

The prob­lem of bad loans is more com­pli­cated. It’s as­so­ci­ated with lo­cal govern­ment bor­row­ing and the bank­ing sec­tor. If too many projects are shut down, lo­cal govern­ments might de­fault and banks might suf­fer losses, which may trans­late into fi­nan­cial tur­moil and slowed growth.

Lo­cal govern­ments have huge debts, which they amor­tize by re­zon­ing and sell­ing land. Al­ready squeezed by ex­or­bi­tant prop­erty prices and pop­u­lar re­sis­tance to land tak­ings, they now face higher in­ter­est rates and prop­erty taxes.

But that’s no rea­son not to fol­low through with cut­ting over­ca­pac­ity. The govern­ment should han­dle the prob­lem with a set of re­forms and tar­get the root of the prob­lem, rather than through ad­min­is­tra­tive mea­sures that fo­cus on short-term ben­e­fits.

In 2014, the is­sue of over­ca­pac­ity will slightly im­prove, but it won’t be cured.

In­dus­trial over­ca­pac­ity is a chronic prob­lem in China. It’s wide­spread and af­fects mul­ti­ple in­dus­tries. Most of the in­dus­tries in ques­tion face ab­so­lute, not struc­tural, over­ca­pac­ity. And the prob­lem is wors­en­ing as there are still many projects in con­struc­tion.

The steel, ship­ping, ce­ment, elec­trolytic alu­minum and sheet-glass sec­tors are among the in­dus­tries hit worst. It’s widely be­lieved that about 20 per­cent of all of the coun­try’s ur­ban and ru­ral jobs are in those five in­dus­tries.

Af­ter this year’s Cen­tral Eco­nomic Work Con­fer­ence held Dec 10-13, a state­ment stressed the down­ward pres­sures on do­mes­tic eco­nomic growth, one be­ing the se­ri­ous over­ca­pac­ity in some in­dus­tries.

There are no up­dated of­fi­cial fig­ures on how bad the prob­lem is, so no one knows ex­actly how much of the ca­pac­ity should be cut off. We need re­li­able data be­fore the govern­ment can tailor an ac­cu­rate strat­egy to solve the prob­lem.

Lo­cal govern­ments had an in­cen­tive to fos­ter in­dus­try growth, and that partly caused the prob­lem. The govern­ments gave com­pa­nies sub­si­dies, dis­counts on land and tax perks to en­cour­age them to set up plants in their ju­ris­dic­tions and push up GDP fig­ures.

Eco­nomic fluc­tu­a­tion is another rea­son. Be­fore the fi­nan­cial cri­sis hit, growth was in high gear.

Com­pa­nies were gen­er­ous when mak­ing new in­vest­ments and the govern­ment was more than will­ing to let them do that. Much of the ca­pac­ity went idle af­ter the fi­nan­cial cri­sis de­pressed de­mand.

In their bat­tle to solve the over­ca­pac­ity is­sue, re­gional govern­ments lack a proper strat­egy. The prob­lem can’t be solved by strength­en­ing the ad­min­is­tra­tive ap­proval process. Over­ca­pac­ity is not un­usual in a mar­ket econ­omy, but a sound mar­ket sys­tem will solve the prob­lem over time through ad­justed prices and in­vest­ment re­turns. In China, the prob­lem of over­ca­pac­ity is to a great ex­tent a re­sult of govern­ment in­ter­fer­ence, so mar­ket-ori­ented re­forms are es­sen­tial to solve the prob­lem.

At the cen­ter is in­ter­est rate re­form, which will re­veal the true fund­ing costs and make in­vest­ment in in­dus­tries with over­ca­pac­ity ex­pen­sive. Of course, that should be sup­ple­mented by a bas­ket of other re­forms, cen­tered on chang­ing lo­cal govern­ments’ in­cen­tives.

Over­all, the cure for the prob­lem lies with the in­vis­i­ble hand, rather than the vis­i­ble hand.

What con­tri­bu­tions would in­vest­ment, con­sump­tion and ex­ports make to the Chi­nese econ­omy in 2014? Do you see a change in the eco­nomic struc­ture from this year? What would be the rea­son for such a change?

China’s econ­omy is in the midst of a fun­da­men­tal tran­si­tion. This tran­si­tion in­volves mov­ing from in­vest­ment to con­sump­tion, from ex­ports to im­ports, and to more pro­vi­sion of so­cial ser­vices such as health and pen­sions by the govern­ment.

This tran­si­tion will be one of the key global eco­nomic trends over the next decade and, be­cause China is so large, it has im­pli­ca­tions for all coun­tries. Over the past five years, in­vest­ment has cre­ated more than half of China’s growth: For the pe­riod of 2009 to 2013, the Econ­o­mist In­tel­li­gence Unit es­ti­mates that in­vest­ment ac­counted for an av­er­age of 5.1 per­cent­age points of growth ev­ery year, as com­pared with 3.2 per­cent­age points for con­sump­tion, 1.2 per­cent­age points for govern­ment spend­ing and -0.7 per­cent­age points for for­eign trade.

In 2014, in­vest­ment will still be the largest source of growth, but it is get­ting smaller. Our prediction is that in­vest­ment will add 3.2 per­cent­age points to eco­nomic growth in 2014, as com­pared with 3.7 per­cent­age points in 2013. This amount will get lower ev­ery year, and be down to 2.3 per­cent­age points by 2018. We think that 2016 will be the year that pri­vate con­sump­tion starts to make a larger con­tri­bu­tion to growth than in­vest­ment.

The share of in­vest­ment in China’s growth has been very large by in­ter­na­tional stan­dards, and it is not un­usual that it should fall. In­deed, there are some ben­e­fits in a greater role for con­sump­tion. The ma­jor ben­e­fit is that Chi­nese peo­ple can en­joy more of the ben­e­fits of eco­nomic growth.

Another big el­e­ment of China’s tran­si­tion is the move from ex­ports to im­ports. Many of those im­ports will be­come part of pri­vate con­sump­tion. The Chi­nese govern­ment’s com­mit­ment to steer­ing the coun­try’s econ­omy onto a slower, more sus­tain­able growth path has raised con­cerns among many of the com­pa­nies and coun­tries that have come to rely on China’s surg­ing de­mand for im­ports.

The pat­tern of Chi­nese de­mand is cer­tainly set to shift over the next five years, but the pace of the change is likely to be slower than some ex­pect, and the coun­try’s im­ports will con­tinue to rise rapidly. China will buy more from coun­tries that pro­duce con­sumer goods, such as the US, and less from coun­tries that pro­duce the types of raw ma­te­ri­als used in in­vest­ment, such as Aus­tralia.

Fears that a slow­down in China’s econ­omy will lead to a slump in ex­port growth in other economies are broadly mis­placed. Al­though the coun­tries that have ben­e­fited most from China’s con­struc­tion boom have the most to be con­cerned about, they should have sev­eral years to ad­just to slow­ing lev­els of Chi­nese in­vest­ment. For oth­ers, the prospects of­fered by the Chi­nese mar­ket re­main bright.

Ex­ports will play a big­ger role in driv­ing China’s growth next year.

We es­ti­mate that do­mes­tic con­sump­tion and in­vest­ment will re­main at a sim­i­lar level next year com­pared to this year.

But the strong ex­ter­nal de­mand re­sult­ing from a re­cov­er­ing United States and Europe will help fuel the GDP growth of the world’s sec­ond-largest econ­omy by an ex­tra 0.3 per­cent­age points.

Our pre­dic­tions show that China’s GDP growth will bounce back to 7.9 per­cent in 2014 from a val­ley of 7.6 per­cent, which is the likely fig­ure for this year. All this ac­cel­er­a­tion will come from im­proved ex­ter­nal de­mand.

With the uptick in global de­mand, China’s ex­port growth will speed up to 10 per­cent from a de­press­ing 7 per­cent pre­dicted for this year.

The ex­tra growth will mainly be a re­sult of the re­cov­ery in the US econ­omy, which, it is hoped, will ac­cel­er­ate to 2.6 per­cent from only 1.6 per­cent this year.

The trend of US eco­nomic growth is highly con­sis­tent with China’s ex­port growth, al­though China’s largest ex­port des­ti­na­tion is Europe rather than the US. This is be­cause a large pro­por­tion of China’s ex­ports head­ing to South­east Asian coun­tries com­prise semifin­ished goods that even­tu­ally go to North Amer­ica as fin­ished prod­ucts.

China’s ex­ports will ben­e­fit, also, from a bet­ter Euro­pean econ­omy that will see a slight re­cov­ery in 2014 from the re­ces­sion of this year. The Euro­pean econ­omy is likely to see 1 per­cent growth next year in­stead of the 0.3 per­cent ret­ro­gres­sion it saw in 2013.

De­spite strong ex­ter­nal de­mand, China’s do­mes­tic de­mand will re­main slug­gish next year.

The coun­try’s av­er­age na­tional in­come is still rel­a­tively low and has many struc­tural prob­lems. The mea­sures in­tro­duced by the Chi­nese govern­ment to boost do­mes­tic con­sump­tion will not change this fun­da­men­tal is­sue, and the av­er­age low pur­chas­ing power of the Chi­nese peo­ple is likely to per­sist for quite a while. As for in­vest­ment, there is both good news and bad news. The Third Plenum called for mea­sures to al­low more pri­vate cap­i­tal in tra­di­tion­ally re­stricted ar­eas such as in­fra­struc­ture. This will cre­ate more chan­nels for pri­vate in­vest­ment and also stim­u­late over­all in­vest­ment growth.

But at the same time, the Cen­tral Eco­nomic Work Con­fer­ence re­it­er­ated the im­por­tance of reg­u­lat­ing the debt scale of lo­cal govern­ments, im­ply­ing that stricter mea­sures will be re­leased next year that will dampen the amount of in­vest­ment ini­ti­ated by those govern­ments.

Con­sid­er­ing both fac­tors, in­vest­ment will re­main at a level sim­i­lar to this year’s.

How do you eval­u­ate the risks of lo­cal govern­ment debt in China? What mea­sures would you pro­pose to help pre­vent and re­solve such risks?

The po­ten­tial for the de­vel­op­ment of a lo­cal govern­ment debt mar­ket in China is look­ing in­creas­ingly likely, given re­forms an­nounced by the cen­tral govern­ment in 2013.

While lo­cal govern­ments are largely re­spon­si­ble for build­ing China’s in­fra­struc­ture, their fi­nanc­ing op­tions are limited. Their own sources of rev­enue and cen­tral govern­ment grants are in­suf­fi­cient, and aside from a small pi­lot bond pro­gram they are pro­hib­ited by law from bor­row­ing di­rectly or guar­an­tee­ing other en­ti­ties.

As a re­sult, lo­cal govern­ments bor­row in­di­rectly through lo­cal govern­ment fi­nanc­ing ve­hi­cles and other gov­ern­men­tre­lated en­ti­ties. Such debt is not con­sol­i­dated in their fi­nan­cial re­port­ing, and, there­fore, the amounts and terms are not trans­par­ent.

A more di­rect lo­cal govern­ment bor­row­ing model, such as we see in many other coun­tries, would seem to of­fer a bet­ter fi­nanc­ing al­ter­na­tive.

But some ba­sic con­di­tions un­der­lie all suc­cess­ful mar­kets. They in­clude: 1) a strong in­sti­tu­tional frame­work with clearly de­fined rev­enue and ex­pen­di­ture re­spon­si­bil­i­ties, and suf­fi­cient re­sources to fund ex­pen­di­tures; 2) de­tailed and trans­par­ent fi­nan­cial, debt and gov­er­nance in­for­ma­tion; 3) clear ac­count­abil­ity for debt obli­ga­tions and re­pay­ment re­spon­si­bil­i­ties; and 4) well-de­vel­oped bu­reau­cra­cies and ad­min­is­tra­tive prac­tices.

The cen­tral govern­ment over the past 18 months has made an­nounce­ments that fo­cus on all of these key fea­tures. These culminated in the Third Ple­nary Ses­sion state­ments in Novem­ber.

Sub­se­quently, dur­ing the Dec 10-13 Cen­tral Eco­nomic Work Con­fer­ence, the cen­tral govern­ment stated that one of its key pri­or­i­ties for 2014 is “lay­ing the foun­da­tion” for a bet­ter con­trol of lo­cal govern­ment-re­lated debt.

We ex­pect to see a greater di­ver­gence be­tween LGFVs in credit qual­ity. Some small and mar­ginal LGFVs will likely face a higher prob­a­bil­ity of de­fault be­cause of a fall­ing level of govern­ment sup­port as the govern­ment’s po­si­tion on this is­sue be­comes clearer, and be­cause their stand­alone pro­files are in­trin­si­cally weak.

But the scale of de­faults will likely be re­strained, and govern­ment sup­port will re­main for LGFVs in­volved in projects im­por­tant to lo­cal eco­nomic de­vel­op­ment and in­fra­struc­ture.

Ibe­lieve lo­cal govern­ment debt will not con­tinue its cur­rent reck­less ex­pan­sion over the next few years.

There are three rea­sons for this. First, “con­tain­ing lo­cal govern­ment debt risk” has been iden­ti­fied as one of the six ma­jor tasks for next year’s eco­nomic work by the Cen­tral Eco­nomic Work Con­fer­ence. This re­flects a wide recog­ni­tion among top lead­ers of the se­ri­ous­ness of the prob­lem.

Sec­ond, the Or­ga­ni­za­tion Depart­ment of the Com­mu­nist Party of China, which over­sees per­son­nel af­fairs within the Party, an­nounced re­cently it would put “the debt raised within a lo­cal of­fi­cial’s term” as cri­te­rion for de­cid­ing his or her ca­reer ad­vance­ment. This would serve as a way to curb the lo­cal govern­ment debt pileup at the root cause.

Third, huge lo­cal govern­ment bor­row­ing has al­ready squeezed out other parts of the econ­omy, and cur­rent eco­nomic con­di­tions can no longer sup­port this scale of bor­row­ing.

The pre­vi­ous model, in which lo­cal govern­ment rev­enues re­lied heav­ily on land sales, has run its course. As prop­erty price in­creases in thir­dand fourth-tier cities lose mo­men­tum, many lo­cal govern­ment fi­nanc­ing ve­hi­cles can no longer re­pay debts from land sales.

What’s more, the obli­ga­tion to re­pay debts has squeezed lo­cal govern­ments’ dis­pos­able pub­lic fi­nance re­sources, and as more LGFVs bor­row, in­ter­est rates pick up, adding more costs to their fi­nanc­ing.

To dis­solve the risks from lo­cal govern­ment debts, it is es­sen­tial to change the opaque­ness of cur­rent lo­cal govern­ment fi­nanc­ing.

The doc­u­ment fol­low­ing the Third Plenum prom­ises to com­pile lo­cal govern­ment bal­ance sheets. That is a good di­rec­tion. The Cen­tral Eco­nomic Work Con­fer­ence has said that dif­fer­ent kinds of debts will be cat­e­go­rized and put un­der broad bud­get man­age­ment. Op­ti­mally, this means that lo­cal govern­ments’ bor­row­ing would be scru­ti­nized by lo­cal leg­is­la­tures, and over­sight would be im­proved.

There is a ma­jor dif­fer­ence be­tween China’s lo­cal debts and those in Western coun­tries. Here, they are mainly used in pro­duc­tive projects and could be trans­ferred into prop­er­ties. Projects that en­joy stable cash flow and that ex­pect fu­ture re­turns could be fi­nanced by the is­suance of mu­nic­i­pal bonds.

Some projects that may reap very lit­tle rev­enue from the projects them­selves but have large ex­ter­nal­ity, such as farm­land and wa­ter con­ser­vancy, could be backed by fis­cal rev­enue.

Another type of pro­ject could in­vite the pri­vate sec­tor to par­tic­i­pate. Along with these, a small por­tion of ex­ist­ing non-per­form­ing loans could be dealt with by lo­cal as­set man­age­ment cor­po­ra­tions.

Wang Haifeng, re­searcher with the In­sti­tute for In­ter­na­tional Eco­nomic Re­search of the Na­tional De­vel­op­ment and Re­form Com­mis­sion, China’s top eco­nomic plan­ning agency

Li Xuesong, deputy di­rec­tor of the In­sti­tute of Quan­ti­ta­tive and Tech­ni­cal Eco­nomics at the Chi­nese Academy of So­cial Sciences

Wang Tao, China econ­o­mist at UBS, a global fi­nan­cial ser­vices firm

Dan Stein­bock, re­search di­rec­tor of in­ter­na­tional busi­ness at the In­dia, China and Amer­ica In­sti­tute

Hua Min, head of the In­sti­tute of World Econ­omy at Shang­hai-based Fu­dan Univer­sity

Louis Kuijs, chief China econ­o­mist at the Royal Bank of Scotland

De­bra Roane, vi­cepres­i­dent and se­nior credit of­fi­cer in the Global Sub-Sov­er­eign Group of Moody’s In­vestors Ser­vice

Li Wei, Shang­hai-based econ­o­mist at Stan­dard Chartered Plc

Zhang Qi, Shang­hai-based econ­o­mist with Haitong Se­cu­ri­ties

Xie Yax­uan, head of macroe­co­nomic re­search with China Mer­chants Se­cu­ri­ties

Simon Bap­tist, chief econ­o­mist and Asia re­gional di­rec­tor for the Econ­o­mist In­tel­li­gence Unit

Xu Gao, chief econ­o­mist with Ever­bright Se­cu­ri­ties Co

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