China faces test of nerve on reform
Another quarter of slower GDP growth, due out today, will add to pressures to revert to easier options or hold firm on economic rebalancing
An export-driven decline in China's economic growth could make today a crucial one for Beijing as its leaders grapple with a looming decision to get back on track with long-delayed financial reforms, or push the panic button to underwrite jobs and stability in the near term.
Data due today is set to reveal mainland economic growth eased for the second consecutive quarter, marking the 11th quarter of slowing growth in the past 13 and putting it back on a downward trend interrupted in the last three months of last year after a brief easing of monetary and fiscal policy in the middle of the year.
"There is a clear sense that there is a looming test of the authorities' tolerance for a slowdown in growth," Tim Condon, the head of Asian economic research at ING in Singapore, told the South China Morning Post.
"Think about what they did last year. It looked like exports were going to slow too much so they eased precipitously in the middle of last year. You really don't have to go back very far to see that they have an unsteady hand on the tiller."
That is a gloomy prospect for those who are banking on Premier Li Keqiang assuming the mantle of Zhu Rongji, renowned as China's arch-reformer when he became premier in the late 1990s.
Li has made encouraging noises to investors anxiously waiting for the restart of a reform effort stalled in part by the global financial crisis and made more difficult to resume by the policy moves still needed to this day to fight the inflation and property bubbles inflated by the 4 trillion yuan (HK$4.54 trillion) stimulus programme unleashed by then-premier Wen Jiabao to deal with the downturn.
But while Li's steady rhetoric of long-term reform and more domestically driven consumption plays well, the reality is that the economy remains heavily exposed to the external sector, with about 200 million jobs - about 25 per cent of the country's workforce - tied directly to export manufacturing, or in foreign-funded firms that depend on relatively cheap Chinese production costs.
Those production advantages are being steadily eroded by factory wage costs that have typically been rising at about 20 per cent in recent years, while data from the Bank for International Settlements shows the yuan has become 15 per cent less competitive on a trade-weighted basis since 2010.
The yuan has gained about 35 per cent against the US dollar since its peg to the greenback was broken in a landmark reform in 2005, but more recent moves have further eroded China's international competitiveness, according to Paul Markowski, the president of New York-based MES Advisers and a long-time external adviser to the mainland's financial authorities.
Markowski points out that the yuan's gains against currencies in fast-growing Asian emerging markets mean the places Beijing was hoping would compensate for lost export demand from the European Union and the United States - China's two biggest foreign customers - are likely to buy fewer Chinese goods.
Meanwhile, the yuan's rally of about 23 per cent against the Indonesian rupiah and 33 per cent against the Japanese yen since late 2011 implies a substantial erosion of China's currency advantage at both ends of the competitiveness spectrum.
Markowski said it was clear that policy settings must be geared towards generating more domestic demand.
Leland Miller, the president of China Beige Book International, which takes the pulse of the mainland's real economy in its quarterly survey of thousands of businesses across the nation, reckons the yuan's rise is the key barometer of the likelihood of reform.
In Miller's analysis, the yuan appreciation engineered by the People's Bank of China shifts the balance between exports and imports, accelerating the drive towards domestic demand through the services sector as opposed to export demand in the manufacturing sector. Higher currency costs make it harder to dump excess capacity overseas, further intensifying the sector shift, albeit making it more painful.
In effect, Miller said, "the PBOC has gotten away with a stealth rebalancing policy".
The question for investors is whether Li is now ready to walk further down the path that the central bank has prepared for him.
Finance Minister Lou Jiwei's revelation last week that 6.5 per cent GDP growth likely marks the pain barrier for the government implies that a little wiggle room is left before that decision is made, given that the consensus view is that economy will grow by at least 7.5 per cent this year.
The hard road of reform would ultimately create a more dynamic, domestically oriented economy, but would likely mean higher prices and volatile employment prospects in the interim while competitive forces took hold. A move to stimulate could underpin growth immediately.
The nagging problem for Beijing is that a failure to rebalance growth definitively towards domestic demand means that policymakers battling the second externally induced economic slowdown in five years are likely to find themselves doing the same for much of the coming decade as consumers in the EU and US continue to work themselves out of the debt they almost drowned in during the financial crisis.
Zhang Zhiwei, the chief China economist at Nomura in Hong Kong, said recent evidence pointed to a policy focused on boosting the domestic economy. "I don't think Premier Li wants to do anything that would jeopardise long-term economic stability. His policy emphasis is very domestically focused."