China: Ignore Misleading Analysis On Reform Reversal

Business, China, Company Strategy

Li_Keqiang,_Chinese_and_foreign_press_conferenceBy John Richardson

A GREAT deal of misleading analysis has been written about this year’s National People’s Congress (NPC) – China’s annual parliamentary meeting – which always takes place every March.

Much of this misleading analysis has been centred on Prime Minister Li Keqiang’s (see picture on the left) announcement during the NPC that a government GDP (gross domestic product) growth target of between 6.5% to 7% had been set for 2016.

This announcement was conflated with a record increase in credit in January as indicating that Beijing was going soft on economic reforms through a return to major economic stimulus.

But this doesn’t add when you look at the bigger picture, and here is why:

  • To entirely abandon annual GDP growth targets would be a political step too far right now. But every serious economist knows that annual GDP growth targets have long been for public consumption only. Sure, Beijing will very probably officially report GDP growth at between 6.5% and 7% for 2016 when this year is over. But this will not mean that actual, real growth has been pumped-up to this level through excessive stimulus.
  • Lots of credit is always pumped into the Chinese economy every January and/or February to meet extra liquidity needs created by the Lunar New Year holidays. What led to the exceptionally high level this year was largely that companies are increasingly borrowing money merely to stand still – i.e. they need extra financing to pay-down existing debt. China will allow what it deems as bad companies to go bust, but if you shock the patient too much during surgery, his heart might stop. The pace of bankruptcies and job losses has to be carefully staggered.

China hasn’t gone soft on economic reforms. Its senior political leaders are instead pursuing the “art of the possible” in the short term, whilst keeping their eyes firmly focused on the long term goals.

Li himself made these long term goals clear when he said at the opening of the NPC: “This is the crucial period in which China currently finds itself, and during which we must build up powerful new drivers in order to accelerate the development of the new economy.”

Reports that 1.8 millions jobs are to be lost in coal mining and steel indicate the continued rapid pace of overall change.

So does anecdotal, on the ground evidence of a “two speed China”.

In the slow lane, as any astute visitor to China will tell you, are the provinces reliant on heavy industries for their prosperity – particularly those that make up China’s north eastern rust belt. Here, local, real GDP growth has sporadically been in negative territory ever since the reform process picked up real pace in early 2014.

Meanwhile, in the fast line remain the provinces much more dependent on services and higher-value manufacturing for their economic growth. These are home to the favoured industries, where, rather than job losses, job creation is the order of the day. They are thus seeing real GDP growth in the high single digits

But, of course, as we said, you cannot close down all the excess coal mines and steel mills etc. overnight. You have to sometimes wait until sufficient new jobs can be provided elsewhere.

This type of long term view of China is of critical importance to the chemicals industry, and is different from the week-by-week or even day-by-day changes in how some analysts view China.

These changes in opinion create short term dips and spikes in equity and commodity markets, but do not mean anything significant in terms of Chinese government policy direction over 5-10 years.

I remain convinced that major “supply side” reforms are well underway, as China attempts to create an entirely new economic growth model. This will be built on services, such as mobile Internet sales, on the manufacturing of internationally recognised high-quality goods – and on the biggest environmental clean-up that the world has ever seen.

What is equally important to chemicals companies is that they do not run away with the entirely false notion that this is going to be an easy, quick and smooth transition. If the transition was turning out to be all of these three things, then why has the government seen at as necessary to introduce “sticking plaster” measures to prop-up old industries?

This transition is instead fraught with risk, might not work at all, and at the very least will result in several more years of much-lower real GDP growth – well below the official, published numbers.

And when the new, and successful China hopefully finally emerges at the end of this process, the way that you do business in China needs to be entirely different.

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