Policymakers in China continue to delicately shift expectations away from an excessive focus on GDP targets. While markets will fret over a slowdown and the risks of a hard landing, these are still tail risks. The central scenario remains a gradual reduction in the GDP floor. While Li said the GDP target for 2014 will be reached earlier this month, we think it likely that the GDP floor will be shifted down to 7.0% from 7.5% as policymakers become more confident the reduction won’t create instability.
While the old leadership of Hu/Wen focused on meeting growth targets, the current leadership of Xi/Li are looking to walk on a different road. Xi/Li understand that traditional fiscal/monetary stimulus creates economic headaches indebted local governments, excess capacity in certain industries, the rise of shadow banking. Thus the focus on more targeted stimulus and flexibility on growth targets. The objective is to strike a balance between reforming the economy and keeping growth on an even keel.
As long as reforms and restructuring do not create significant externalities – especially in employment – Beijing is showing a clear willingness to tolerate slower growth. After the downward shift to single-digit growth from double-digit growth, the quick drop in targets/floors to 7.0% from 8% just two years ago shows that we are in a more delicate phase. More delicate because it means finding a goldilocks pace that is neither too hot nor cold.
Smart/targeted stimulus along with reforms and restructuring has already led to yo-yoing of expectations, which is set to continue. Uncertainty over how much growth is needed to support the labour market, incomes and consumption justifies a cautious approach to any lowering of growth target beyond 7%.
A less frothy China continue to be negative for commodity prices and currencies (AUD and BRL), but in the longer term it is a positive by reducing the risks of a more damaging slowdown.
China has learnt from the financial crisis the dangers of allowing excesses to build, whether this is related to shadow banking, excessive debt or credit growth. The markets will always worry that China’s reform efforts will derail the economy. But Beijing looks determined to push through reforms and tolerate slower activity as long as employment growth is not impacted.