China’s Economic Policymakers Turning a Page

Written into the script for China’s once-in-a-decade leadership shuffle, confirmed at the recently concluded National People’s Congress, are macroeconomic policies for the new government that plot a course for future growth.

The policy book has already landed on the desk of a government led by newly installed Premier Li Keqiang, who succeeded Wen Jiabao. Chapter one, page one sets a 7.5 percent GDP growth target for 2013, down from the 7.8 percent expansion achieved last year.

Policies described in subsequent chapters take aim at some of the country’s toughest challenges, including factory overcapacity, rising operational costs, and slower government revenue growth.

Contrary to the expectations of many investors, policymakers have decided not to seek any big increases in government investment this year. Rather, they want to prevent any possible financial trouble tied to local government debt and the off-balance-sheet operations of commercial banks. That means regulations covering local government financing platforms are likely to be tightened.

Also highlighted in the government policy book are plans to seek quality over quantity in economic growth, adjust real estate and business tax structures, control housing prices, and rein in fiscal spending.

Zhu Baoliang, director of the Economic Forecast Department at the State Information Center of the State Council, said that the government this year above all else plans to work toward stable growth and preventing financial risks.

The plans are likely to test the government’s capacity to balance de-leveraging and financial stability, said Liu Yuhui, chief economist at Huaitai Securities. The new leadership will also be expected to accept, to some degree, an economic slowdown.

“Judging from the current economic targets,” Liu said, “the government’s tolerance is rising.”

Modest Target

In addressing the NPC, Wen said the decision to lower this year’s GDP growth target was based on an understanding of the economy’s momentum and an urgent need for structural readjustment.

Indeed, the new leadership in Beijing has been tasked with a shift in focus to quality-based growth rather than simply impressive GDP figures, said Liu. This change reflects an awareness of pressing issues such as high leverage and the weakening growth momentum.But achieving even 7.5 percent growth—which would add roughly 4 trillion yuan to a national GDP that reached 51.9 trillion yuan in 2012—could be hard to achieve, said Zhang Zhuoyuan, an economist at the Chinese Academy of Social Sciences.

Niu Li, a macroeconomics researcher at the State Information Center, agreed. He cited “pressures” that could stand in the way of reaching the target, such as concerns over environmental degradation, food safety, the nation’s wealth gap, and local government officials who put their own careers ahead of sustainable growth.

“The current problem is not slower economic growth, but that local government [officials] pursue higher political assessments by blindly expanding investment and sacrificing the environment,” said Zhang, who favors a GDP growth rate target that’s under 8 percent.

Zhang said the government should work harder to boost the economy by expanding the service and tertiary sectors.

On the monetary policy front, the government has a plan to increase M2, the broad money supply, by 13 percent this year compared to 14 percent last year.

People’s Bank of China Governor Zhou Xiaochuan told the NPC delegates that this slowdown in money supply growth underscores the government’s interest in price stability.

“If we can continue to control M2 growth at a reasonable level,” Zhou said on March 13, “there shouldn’t be any sudden increase in inflation.”

The government set this year’s inflation target at 3.5 percent, below last year’s 4 percent.

No Investment Rush

Wen’s policy plan set this year’s investment growth target at 18 percent, higher than last year’s 16 percent. The fiscal deficit is set to rise to 1.2 trillion yuan from the 800 billion yuan reported in 2012.

And fiscal revenue growth is expected to slow against a backdrop of rising expenditures, especially social welfare spending, and business tax cuts, said Liu Shangxi, deputy director of the Ministry of Finance’s Fiscal Science Research Center. Spending is expected to steadily rise in areas such as education, public health care, and environmental protection.

“Future deficits will be above the 1 trillion yuan level,” said Liu.

NPC delegates reviewed a central government National Economic and Social Development Report that detailed plans for 437.6 billion yuan in government spending this year, up 35 billion yuan from 2012. Investment targets will focus on subsidized housing, agriculture, transportation, energy, environmental protection, and other public projects.

Local government officials haven’t lost their zeal for investment-based growth, according to a survey conducted by Haitong Securities in late February. Many are still counting on investment to boost local economies, the report said, despite an uncertain outlook for future financing.

Access to bonds and other sources of capital will be significantly narrowed this year for local government financing platforms, said Huang Yiping, the Barclays Capital Chief Asia economist. A key reason is that the central government, as repeatedly emphasized in State Council reports, wants to improve local government debt management and control potential risks.

The National Audit Office said in late 2010 that debt among provincial, city, and county governments totaled 10.7 trillion yuan. These governments had 6,576 investment platforms that altogether had borrowed 4.97 trillion yuan, the report said.

But some experts say no one really knows how much money is owed by local governments. For example, Bai Chongen, an economist at Tsinghua University, said commercial banks’ data on this particular debt issue may be incomplete.

Bai says transparency is needed as a precondition to control local government finances, and he’s called on governments to publicize their asset and liabilities.

Stimulus Package

No one denies, though, that government spending has long been a major driver of economic growth.

Moreover, fiscal spending via a 4-trillion-yuan stimulus package launched by the central government in 2009 following the global financial crisis “proved to be a correct decision,” Wen told the NPC.

The package included 1.26 trillion yuan in direct investment from the central budget and policies designed to support industrial development, technological innovation, and social welfare projects.

Tax cuts that encouraged purchases of low-emission vehicles and government support for third-generation wireless Internet services were among the complementary measures adopted by the government to fight the financial crisis, said Li Yizhong, the head of the Ministry of Industry and Information Technology.

Li said “the measures were effective in general” but were implemented to address special circumstances and should not be set in stone.

Indeed, the 4-trillion-yuan package has had some negative effects that show why the government is not keen for a repeat. For example, the investment spike has led to overcapacity in some industries, too much new infrastructure, high local government debt risks, and excess liquidity.

The government stimulus has also been blamed for squeezing out the private sector in certain business areas.

The biggest concerns revolve around local government debt, which Huang said ballooned after the stimulus program kicked off. The central and local governments, as well as enterprises, borrowed heavily without clear repayment plans. “Without clarifying [payback] responsibility, a default crisis will be inevitable,” said Huang.

A recent Standard Chartered Bank report predicted the central government may have to inject capital into the banking system within five years to offset loan defaults tied to local government borrowing.

Discussions about government stimulus packages are expected to continue against a backdrop of calls for policy changes.

Lin Yifu, a former World Bank chief economist and honorary dean of the National School of Development at Peking University, said liquidity could be better controlled if fiscal policies were used as levers for future macroeconomic adjustments.

Ni Hongri, a senior researcher at the State Council’s Development Research Center, noted that while the Ministry of Finance has little say in key policymaking areas such as infrastructure investment and the financial sectors, it’s expected to rescue governments that default.

Housing and Taxes

One of the tax issues that attracted a lot of attention at the NPC was a government decision to impose a 20 percent tax on profits earned from the sale of a home. Ni said the idea is aimed at better controlling housing prices by preventing sharp spikes and dramatic slumps.

The proposal, however, triggered debates and sparked a surge in transactions in many cities as buyers and sellers race to beat the proposed new rules.

Ni sees room for more deliberations over the plans for a real estate tax, which she said could push prices higher. “Housing demand is still, in general, larger than supply,” Ni said. “Theoretically, [the tax] would transfer the tax burden to buyers, thus pushing up prices and market speculation.”

Housing and Urban-Rural Development Vice Minister Qi Ji recently told state broadcaster CCTV that the tax policy would be designed to curb speculation on the housing market, but may hurt consumers as well.

The government has for years struggled to restrain property prices, and analysts said that effort is continuing this year.

The State Information Center’s Zhu said incoming “hot money” from abroad is the main reason property prices have been rising.

China’s funds outstanding for foreign exchange, which refers to Chinese banks’ foreign currency purchases, increased in January by 680 billion yuan from the previous month to an all-time high, the central bank said. Zhu said this fact points to a surging inflow of hot money.

Zhu said that since the government does not have “a long-term mechanism” to adjust the market, “we have to adopt such short-term measures,” such as real estate transaction taxes.

A property tax on owners would be more suitable than a transaction tax, Zhu and other researchers said.

So far, local government officials have hotly resisted central government efforts to levy property taxes. But even without local support, Zhu said, central authorities should adopt a property tax system.

Zhang, meanwhile, said rolling out a property tax scheme would improve the government’s credibility, which has slipped among the public due to years of wavering on housing market controls.

Jia Kang, a delegate to the Chinese People’s Political Consultative Conference and director of the finance ministry’s Institute of Research, said there’s “a big possibility that a property tax pilot program will be launched in 2013.”

In addition, officials say the government’s policy book outlines plans to implement tax cuts.

The State Council’s budget report mentions this year’s fiscal policy includes plans for a “structural tax cut” made possible by converting what’s now a business tax to a value-added tax.

The government has projected fiscal revenue to grow 8 percent this year and tax revenue to jump 8.5 percent. Last year, tax revenues grew 12.1 percent—significantly higher than the 9.6 percent target set in the government’s 2012 policy book.