Even as Beijing continues to be gripped with uncertainty and rumors of political intrigue surrounding the ouster of a populist leader captivate the blogosphere, more mundane things are on policy makers minds. The release of a manufacturing index suggests tougher times ahead for the Chinese economy and may provide room for interest rate cuts ahead. Longer term, many economists argue that China must liberalize interest rates, still tightly controlled by Beijing.
The HSBC purchasing managers index had a preliminary reading of 48.1 for March, a fifth straight monthly decline and the longest slump since the global financial crisis. That compares with a final of 49.6 for February, with any reading below 50 indicating a contracting economy. Thursday’s so-called Flash PMI (“Flash” because it is preliminary) is based on responses from 85 percent to 90 percent of the 400-plus companies surveyed each time and shows they are expecting a continued economic slowdown. The final survey reading is expected to come out March 30. Goldman Sachs (GS) said in a note Thursday that the possibility of interest rate cuts has “significantly increased recently.”
The bad news follows China’s economic growth slowing throughout last year, coming in at 8.9 percent in the last quarter. In response, China’s central bank has cut bank reserve requirements twice since November but still has not cut interest rates (one-year lending rates are now set at 6.56 percent) since the height of the global financial crisis in 2008. In his annual State of the Union work report given at China’s National People’s Congress earlier this month, Premier Wen Jiabao set a growth target of 7.5 percent this year, down from the 8 percent goal since 2005. Wen also stressed that the challenges ahead in 2012, including guiding China to an economy rebalanced from investment and more toward consumption.
“Internationally, the road to global economic recovery will be tortuous; the global financial crisis is still evolving,” said Wen Jiabao on March 6. “Domestically, it has become more urgent but also more difficult to solve institutional and structural problems and alleviate the problem of unbalanced, uncoordinated, and unsustainable development. In addition, China’s economy is encountering new problems. There is downward pressure on economic growth. Prices remain high. Regulation of the real estate market is in a crucial stage. In setting a slightly lower GDP growth rate, we hope to make it fit with targets in the Twelfth Five-Year Plan and to guide people in all sectors to focus their work on accelerating the transformation of the pattern of economic development.”
“So far the pattern of growth in China has been remarkably industry heavy and investment heavy,” points out Louis Kuijs, an economist at the Fung Global Institute in Hong Kong. He notes that private consumption’s share of China’s GDP has actually declined over the past decade, falling from 46 percent in 2000 to 33 percent in 2010, and probably remained at around that level last year. “China for quite a while has been faced with this challenging task of rebalancing the economy,” Kuijs says.
Tough times at home and abroad could provide more impetus for reforms, said Nicholas Lardy, economist and senior fellow at the Peterson Institute for International Economics in Washington, speaking Wednesday with Bloomberg TV at the Westin Chaoyang Hotel in Beijing. “If you have a big external headwind like China has then you’ve got to look for other sources of growth, and the obvious one for China is to increase consumption,” Lardy said. “With further slowing in Europe, I think it will strengthen the hand of reformers who want to undertake initiatives that would help private consumption.”
What is key? “Reforming deposit rates because it’s a huge tax on the household sector. It’s depressed consumption,” said Lardy. China tightly controls its interest rates, and with deposit rates at only 3.5 percent, Lardy and other scholars argue that savers are penalized at the benefit of borrowers, including China’s big state enterprises. On March 21, central bank governor Zhou Xiaochuan said conditions are “basically ripe” for interest rate liberalization.
Meanwhile, political infighting ahead of the Party Congress this fall isn’t making things easier. Over the last few days China’s blogosphere has been rife with reports of political intrigue surrounding the recent ousting of princeling Bo Xilai. With “the political environment more uncertain, it probably makes it more difficult to push ahead on domestic reform,” Lardy says. “Everyone’s being very cautious right now trying to get through the transitions. So if we see progress, I think it’s likely to be after the party congress in the fall.”