CHINA'S economy is perking up. The latest data suggest growth has bottomed after hitting a trough of 7.5 per cent year-on-year in the second quarter of the year.
We think this recovery is sustainable, unlike last year when GDP growth rebounded in the fourth quarter, before slowing unexpectedly.
The key difference is that this round of stimulus is more wide-ranging. It includes investment in infrastructure, IT, public housing and
environmental protection, as well as VAT reform and tax breaks for small and medium-sized enterprises. This provides a short-term counterbalance to the slowdown in growth and also helps the economy rebalance.
It is less likely to exacerbate existing structural issues Beijing is currently addressing and should help generate better returns from projects linked to the country's broad urbanisation push.
Bear in mind that Beijing has plenty of fiscal and monetary ammunition left should it need to protect growth later on.
While the mini-stimulus should support a modest recovery into the first half of next year, in order to sustain a growth rate of 7.5 per cent or more, we believe China needs to introduce and implement structural reforms.
While some reforms will likely involve some short-term pain, we expect major reforms, due to be announced in November, to boost pent-up private sector demand for investment and consumption, putting growth on a more healthy and sustainable path in the coming years.
We expect:
• a reduction in the government's role in business and deregulation of state-dominated sectors (especially services) in order to help private enterprise;
• financial reforms to ease financing difficulties for private investors and small business; and
• improved income distribution to unleash the consumption power through fiscal reforms and deregulation, which should increase demand for services such as IT, elderly and medical care, and culture.
So, what's driving the latest rebound?
While export growth recovered in the
July-August period, the key driver is on the domestic front, as Beijing's fine-tuning measures have started to lift business confidence and hold up investment demand.
Investment growth picked up to 21.4 per cent year-on-year in August from less than 20 per cent a few months ago as the acceleration in infrastructure investment offset the weakness in manufacturing and property investment.
Infrastructure-led investment demand has led to producer prices bottoming out as companies start to restock.
Reforms: getting the job done
There is no doubt in our mind that putting the right reforms in place will both help cement the recovery and lay the foundations for the next leg of growth.
The reforms must contain real measures that will deliver real change.
It is clear that sustainable growth would hinge on what happens on the domestic front, rather than a recovery in global demand.
Domestic demand has contributed more than
106 per cent of China's growth over the past five
years, which means net exports made a negative contribution. To sustain domestic demand, we believe two things are crucial: 1) generic growth in both investment and consumption demand; and
2) removal of obstacles so that supply-side conditions can fully meet the rise in demand.
Deregulation to revitalise private investment
Investment should remain the important growth driver for the foreseeable future. With huge
urbanisation-led investment demand, the challenge is how to ensure sustainable and efficient investment growth.
The recent rebound in investment growth is mainly driven by government-backed infrastructure investment.
However, this comes with a long list of related problems – such as inefficiency, corruption, limited sources of funding and the risk of rising local government debt.
We believe the answer lies in encouraging private investment, currently representing more than 60 per cent of China's total investment.
Qu Hongbin and Sun Junwei are economists for HSBC Global Research.
