7.5 Percent, Indispensible and Achievable

Why does China have to maintain a relatively high growth rate? This can be ascribed to the following four reasons. First, a relatively high growth rate can create more jobs. The yearly employment demands of its growing labor force keep increasing in China, and this year 10 million new urban jobs will be needed, which can only be met with economic growth. Second, the problem of excess production capacity persists in China. If the economic growth rate drops sharply, this problem will deteriorate, curtailing investment opportunities, aggravating downward pressure, and thereby trapping the Chinese economy in a vicious cycle. Third, a reasonable growth rate could help China avoid debt risks. If the economy shows a drastic downturn, the loan usage rate of existing projects will be lowered, thereby also lowering the rate of return and heightening debt risks. Finally, the government also needs healthy growth to bring in sufficient revenues. If the growth rate is too low, government finances will face stringent restrictions.

China’s economic growth target is not only achievable, but also  creates opportunities for higher growth quality and efficiency. Domestic and overseas scholars agree that achieving this target requires a reliance on domestic demand, but continue to disagree over whether this demand will come from investment or consumption.

With a faltering world economy, if China seeks to achieve quality economic growth by relying on domestic consumption, it has to ensure constant increases in people’s incomes. If this condition is not met, increasing consumption would only lead to a spike in debt, which could trigger a crisis. This is true for both individual households and countries. To achieve a sustainable increase in household income, labor productivity has to be raised; and higher labor productivity can only be achieved through technical innovation, industrial upgrades and infrastructural improvement, all of which require more investment.

To transform its economic growth from the old export-driven mode to one led by domestic demand, China has to rely on investment. In the short term, investment will increase demand and employment, which could drive up the economic growth rate. Good investment will raise labor productivity in the long run and allow people’s incomes to enjoy sustainable increases, giving them the means to buy and invest. Sustainable economic growth could then be realized without negative aftereffects.

Two questions then emerge: Are there good investment opportunities in China? And, are sufficient investment resources available? The answers to both are favorable. As a middle-income country, China has immense space for industrial upgrading, which could bring about a spate of investment opportunities. For example, the improvements in urban infrastructure, like subways and various pipelines and networks, require high investment, Meanwhile, livelihood projects, affordable housing projects and environment management projects all feature high social and economic returns.

China’s investment resources are highly abundant. Last year, the aggregate volume of China’s central and local government debt accounted for 39.4 percent of its GDP – quite a low level compared to the rest of the world. China’s personal savings rate is approaching 50 percent, and its foreign-exchange reserve stands at US $4 trillion. If China could make good use of these available investment resources, it would achieve healthy and quality economic development. 

Local Financing Platforms

Funding for infrastructure, livelihood projects and environmental protection mostly comes from local governments. When local governments make such investments, they are not allowed to issue bonds, which leads to the establishment of various financing platforms. Most investments made by local governments are long term, while loans from these financing platforms are short term, giving rise to problems engendered by this maturity mismatch.

In the past, local governmental financing platforms mainly obtained loans from banks. However, nowadays, in order to control risk, banks have decreased loans to local financing platforms, which consequently have prompted such platforms to resort to shadow banking. Shadow banks lend at high interest rates and lack supervision, which leads to heavier burdens on local governments and exposes them to greater financial risks. Although infrastructure projects, livelihood projects and environmental protection projects initiated by local governments feature a high social return rate, the rate of their economic return is usually around three percent, according to some research; in contrast, the loan interest rate of shadow banks may be as high as seven to eight percent.

How could this problem be solved? In the long run, laws should be amended to allow local governments to issue bonds. In the short term, as the 2014 government report mentions, the central government could first issue debt securities on behalf of local governments. This year, China plans to sell RMB 400 billion worth of government bonds, and the volume could be raised to RMB 1 trillion or more if necessary. Meanwhile, local governmental financing platforms should be given better access to regular banks for loans, since these institutions demand a lower interest rate and are better regulated than shadow banks.

Industrial Upgrading

As already cited, industrial upgrading will bring about many investment opportunities. Nevertheless, to accomplish industrial upgrading, two conditions are required.

First, industrial upgrading requires better financial support. The Third Plenary Session of the 18th CPC Central Committee has put financial reform on the government agenda, deciding to let the market determine interest rates, and to build a multi-level capital market. This reform orientation must be provided with supporting measures, otherwise the results could fall short of expectations. The current reform of interest-rate liberalization, aimed to stimulate flow of funds to productive and well-managed enterprises, is making brisk headway. However, during this reform, some regional governments have taken loans from shadow banks rather than regular banks, because, with soft budget constraints, they are generally insensitive to high interest rates. In this circumstance more capital flows to local financing platforms than to enterprises. The best solution is to allow local governments to issue bonds, which have lower risk and interest rates than corporate bonds. With both local government bonds and corporate bonds available in the market, investors can make selections based on their own risk tolerance and expected returns on investment. Currently,  local financing platform debts, with lower risks and higher interest rates,  have stymied the development of corporate bonds.    

To promote interest-rate liberalization, the financial structure should also be improved. It is necessary to develop small and medium-sized regional banks to provide better financing services to the majority of farmers and micro, small and medium-sized businesses. At present, setting up small and medium-sized regional banks requires having existing commercial banks as the strategic investor – an unreasonable rule which should be abolished. Another decision made by the Central Committee should be implemented: to allow qualified private capital to establish small and medium-sized regional banks. 

Secondly, industrial upgrading needs government coordination and support. Industrial upgrading needs to seek out new industries with comparative advantages, during which the problem of information asymmetry arises. If the first enterprise to invest in a new industry fails, it has to assume all the losses, yet if it succeeds, other enterprises follow on rapidly, so reducing the profit margin. As a result, smart entrepreneurs are often unwilling to be the guinea pig. It should be also noted that many elements for industrial upgrading are out of the control of individual enterprises. For example, new industries often need industrial clusters to solve logistics problems, while the formation of industrial clusters requires the presence of a large number of enterprises in an area. This is impossible without coordination. Furthermore, new industries call for new technicians, skilled workers and infrastructure, which also depend on the government. In the field of industrial upgrading, as mentioned in the government work report by Premier Li Keqiang, it is necessary to give full rein to both the invisible hand of the market and the visible hand of the government.

Although the external environment in 2013 was intricate and complex, the new Chinese government has weathered these tests and performed well. To look ahead in 2014, as long as we strengthen reforms I believe the GDP growth goal of 7.5 percent is within reach.

China’s Dongfeng Motor Group Co., Ltd. signs an agreement with PSA Peugeot Citroen (PEUP.PA) in Paris on March 26 on the € 800 million purchase of 14 percent of PEUP.PA stock equity.