The news is very straightforward. China will cut its target for economic growth this year to 7.5% from the 8% goal that’s been in place since 2005, Premier Wen Jiabao told the annual meeting of the National People’s Congress today.
But what does it mean?
Financial markets have decided that a lower-growth target means China’s leadership is forecasting lower growth. That conclusion is one reason that stock markets were down around the world Monday — from a 1.4% drop in Hong Kong’s Hang Seng Index to a 0.8% decline in the German DAX to a 0.6% slide in the S&P 500 ($INX -0.39%) Monday afternoon. (China’s GDP climbed by 8.9% in the fourth quarter of 2011 and by 9.2% for the full year. That was down from the 10.4% growth in 2010.)
But I think the market’s conclusion doesn’t fit well with all the other policy statements that accompanied the setting of a lower growth target.
First, Wen did not change any of the previous language about economic and monetary policy. The government will maintain a “proactive” budget policy and a “prudent” monetary policy. Nothing there to indicate any change in course tied to the 7.5% target.
Second, the government’s announced growth policies were actually slightly less pro-growth than expected. The money supply target was set at 14% — slightly below the median forecast of 15% among economists surveyed by Bloomberg. The growth target for fixed-asset investment was set at 16%. That’s below the 18% forecast by economists. Coming in with targets for less stimulus than forecast certainly isn’t what you’d expect if China’s leaders were indeed worried about a hard landing for the country’s economy.
Third, the heads of China’s big state-controlled banks are still talking about growth in new loans similar for 2012 to that in 2011 and about further reductions in the bank reserve ratio by the People’s Bank. Here again this is business as usual.
Maybe the big banks haven’t read the memo sent down from Beijing.
Or maybe the change in the target doesn’t mean what the markets have decided it means.
I can think of two alternative explanations.
Alternative explanation #1: Cutting the growth target to 7.5% is an insurance policy for the new leaders that will start taking over the reins in October. Hey, if after setting the growth target at 7.5%, it comes in at 8% or 8.5%, then the new leadership takes office riding a wave of economic success. Think of the new target, then, as an attempt to lower expectations.
Alternative explanation #2: The lower target has nothing to do with any actual forecast for China’s economic growth in 2012. Instead it’s a sign to local leaders that they have more leeway to implement needed economic reforms without getting a black mark on their records if growth doesn’t meet the previous 8% target.
China’s leaders — or apparently a majority of the current nine-man Politburo at least — have spent the last year talking about the need to rebalance China’s economy. The goal would be an economy less dependent on exports and spending on fixed assets such as real estate and infrastructure and more dependent on growth in the consumer sector.
The big problem with that plan — especially if you’re a local leader accustomed to being graded on hitting Beijing’s growth target — is that implementing the new plan is risky. Local leaders know how to generate numbers under the current economic model that show 8% or better growth. But hit the target while shifting to model based on growth in consumer spending? Exactly how do you do that?
By lowering the goal to 7.5%, Beijing gives local leaders more room for error — and that should encourage them, the thinking in Beijing might go, to implement the new policies.
How do investors decide which of these three explanations is correct?
I think we’ll get a good indicator when China announces consumer price inflation for February. Along with cutting the growth target for 2012 to 7.5% from 8.0%, the government also kept its inflation target for 2012 set at 4%.
On the surface, keeping that target at 4% would seem to tie the hands of the People’s Bank on further reductions in the bank-reserve ratio and a first cut in its benchmark interest rate. After all, inflation climbed back to 4.5% in January, putting a halt to months of steady decline from the July peak at 6.5%. If inflation is headed back up, or even if it’s stuck at 4.5%, the central bank won’t be able to do very much to stimulate the economy. You’d think, then, that if China’s leaders were worried about economic growth in 2012 that they’d have cut the bank some slack by raising the inflation target.
But many economists have noted that the January inflation number was distorted by the early Lunar New Year holiday. They’re expecting that the official data to be released on Friday will show that inflation has dropped back in February to 3.4% or so. That would give the People’s Bank plenty of room to stimulate the economy even with a 4% inflation target.
Of course, Beijing’s leaders already know what Friday’s announcement will say. If the inflation number comes in significantly below January’s 4.5% — and especially if it comes in below 4% — I think that’s a sign that China’s leaders think they’ve got plenty of tools for making sure that growth doesn’t slow more than they desire. And that the 7.5% target isn’t a signal of a hard landing in China but of confidence that the country’s economy has enough momentum to tackle the rebalancing that it needs for the long run.
