China: Growth, reform or both?

Is China’s government more focused on short-term growth or long-term reform? Those hoping for a clear answer are getting disappointed.

At the turn of the year, the answer seemed to be clearly reform: leaders had pushed forward with a new agenda in November and seemed unafraid to disrupt local governments, state-owned enterprises and even currency markets. Since then, the pendulum has swung back toward supporting growth, as a housing market correction meant the official 7.5% GDP growth target for 2014 was in severe danger of being missed.

But just when it seemed that reformers had given in and were ready to do whatever it took to pump up growth, the waters have been muddied again. At a meeting of the ruling Politburo on Monday, the leadership approved a plan for fiscal and tax overhauls to be completed by 2016, as well as one on reforming the household-registration system to promote urbanisation. This is significant because fiscal reform and urbanisation have been two areas where the substance has not kept up with the rhetoric; more progress has been made to date in financial reform and Xi Jinping is trying to reinvigorate progress in those lagging areas. And to reinforce the point that it is not just a matter of business-asusual, the Politburo also announced the most senior target yet of the anti-corruption campaign: retired General Xu Caihou, himself a former Politburo member.

The message from these mixed signals is that China will try to pursue growth and reform simultaneously. Since Beijing continues to believe, rightly or wrongly, that it can have its cake and eat it too, it doesn’t accept that it has to choose one key priority. Short-term stimulus measures will have little effect on confidence without others that improve the private sector’s longer-term prospects. Conversely, a virtuous diet of structural reforms is likely to prove unsatisfying if growth plunges. So what we should really expect from Chinese policy are measures that do a bit for growth and also move forward reform.

On Monday, banking regulators announced a technical change in how banks’ loan-to-deposit ratios get calculated, which will have the effect of allowing them to lend more before they reach the cap on the ratio. This is clearly another move to support credit growth. But the strict regulatory cap on the loan-to-deposit ratio is in fact one of the major impediments to liberalising interest rates in China.

The regulation incentivises banks to hoover up deposits at the end of every quarter (when the ratio is checked), a process that causes huge volatility in interbank interest rates because of the surge in demand. Such volatility makes it impossible for short-term interbank rates to carry clear signals of monetary policy from the central bank, as they would have to in a liberalised regime. So the marginal relaxation of the ratio is a welcome sign that conservative banking regulators have started to accept the central bank’s arguments for phasing it out.

In housing policy there is a agendas. With housing sales government has allowed cities similar convergence of declining, the central to start relaxing certain restrictive policies. Last week Hohhot, the provincial capital of Inner Mongolia, said it would no longer prevent home purchases by households which already own a property or by non-residents of Hohhot. Clearly the intention is to support housing sales. But it’s also the case that these restrictions, in force in most major cities, are distortionary and clearly unsustainable over the long run—not least because they block purchases by new migrants, the main source of urban population growth in China. Since the restrictions have to be removed eventually, it might as well be done when the economic cycle can get the most benefit. Of such happy coincidences is Chinese economic policy made.