Although Beijing's new policymakers are focusing on structural reforms with greater tolerance for slower growth, this does not mean that they will tolerate a dramatic slowdown.
The Chinese premier, Li Keqiang, said last week that China must prevent growth from dropping below a minimum rate required to ensure labour market stability, which we believe is around 7 per cent.
We expect some more moderate measures, including additional fiscal spending on public housing, to put a floor on the slowdown.
Premier Li said China would ensure that the economy operated within a reasonable range, avoiding GDP growth from sliding below the minimum rate required to maintain labour market stability and prevent inflation from exceeding the "upper limit".
He believes that stabilising growth can create favorable conditions for the implementation of structural reforms that can boost long-term growth potential.
Premier Li called for coordinated policies to strike the balance between stabilising growth and pursuing structural adjustments.
China has a number of likely policy fine-tuning tools at its disposal.
On the fiscal front
• Beijing can speed up fiscal spending with RMB960bn in fiscal revenue in the first five months of this year (versus a budget deficit of RMB1,200bn).
• More importantly, as the state council's calls for "making full use of outstanding fiscal funding", Beijing should spend its accumulated fiscal deposits of over RMB3.5trn (as of May 2013), or around 7 per cent of China's GDP, on targeted areas such as shanty town renovation, public housing, education, medicare and some infrastructure projects.
• Shift government spending from administrative expenditure to education, healthcare and other social welfare areas.
• Increase the size of local government bond issuance to provide funding for public housing and other infrastructure projects.
On the monetary front
• In terms of quantity, the current pace of credit growth is already accommodative enough to support 7.5 per cent GDP growth, so there is no need to accelerate. But a meaningful slowdown is also unlikely, in our view.
• In terms of interest rate, there is room for a modest rate cut. As the producer price index has stayed firmly in contractionary territory, falling for the 16th consecutive month (the longest period of negative readings since 2001-2002), this means a higher real interest rate.
As enterprises face mounting challenges of slowing orders and rising inventories, higher real interest rates have struck another blow.
With the inflation outlook benign and headline CPI well below the People's Bank of China's 3.5 per cent annual target, there is room for the central bank to cut interest rates by 25bp in the coming months, likely accompanied by widening of interest rate floating band. This will help reduce funding costs and boost business confidence.
The bottom line is, Beijing can and will strike a balance between maintaining growth stability in the short-term while implementing structural reforms to support sustainable growth.
With inflation well below the PBoC's 3.5 per cent annual target, we expect some moderate fiscal and monetary measures to put a floor to China's slowdown. Our growth forecast is 7.4 per cent for both 2013 and 2014.
