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Beijing has trotted out many of the same stimulus policies used after the 2008 Lehman Brothers collapse to stimulate growth. China’s central bank cut its benchmark interest rate twice in less than a month recently, and the amount of cash that banks must hold in reserve has been reduced to encourage lending. The government is also fast-tracking approvals of new infrastructure projects. Some economists expect more such action to be taken in the second half of the year.
In doing so, however, Beijing will only exacerbate the frightening distortions within the economy. Easier money will fuel even high levels of debt, which have already spiked in recent years. That will come to haunt the financial sector in the form of increased numbers of bad loans. Much of any new lending would end up in the hands of state companies, which are terribly inefficient and wasteful. In other words, large-scale stimulus measures will perpetuate the economy’s reliance on investment, leaving it continually vulnerable rather than building new sources of growth. Rating agency Fitch warned earlier this month of the dangers of pursuing this strategy:
Renewed reliance on investment to support activity threatens to prolong the Chinese economy’s structural imbalances … Statements by senior officials including Premier Wen Jiabao have pointed to renewed emphasis on investment to support growth in the remainder of the year. An investment-led strategy backed by monetary easing is likely to avoid a “hard landing” in the short term … However, this investment-led strategy is likely to be at the cost of postponing resolution of the economy’s structural imbalance towards investment. Moreover, the rise in investment as a share of GDP since 2008, which is inherently unsustainable, has coincided with deteriorating efficiency as measured by the ratio of incremental output per unit of investment.
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Yet at the same time, there are indications that China’s policymakers understand the risks inherent in massive stimulus. The current efforts to propel growth are far smaller in scale than what the government employed in 2008–09. Key restrictions on the property sector, like measures to limit speculative purchases of apartments, have remained firmly in place even as the sector has faltered. And as Michael Pettis, a finance professor at Peking University, pointed out in the Financial Times the other day, China has allowed real interest rates to rise substantially — a measure that would curtail investment while boosting the income of savers and thus consumption. Such a policy direction would inevitably lead to slower but ultimately healthier growth — a course, Pettis convincingly argues, the rest of the world should encourage:
As China rebalances we would expect slowing growth and rapidly rising real interest rates, which is exactly what we are seeing. Rather than panicking and demanding that Beijing reverse the process, we should be relieved that China is finally solving its problems.
The intentions of China’s policy mandarins will become clear over the next few months. Taking the proper reform measures will require the government to accept a lower growth rate while the economy adjusts. Will they take more drastic steps to pump up the country’s existing but strained growth model or earnestly start the process of creating a new growth model? The future of China’s economic miracle may well depend on the answer.
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