China: Waiting for policy tailwind
A year after the restrictions imposed because of the COVID-19 pandemic were lifted, China's economic recovery still lacks enough momentum. One thing is clear: China's economy as of today is operating at below potential. We believe a sizable negative output gap emerged in 2022 that has persisted in 2023, judging from the low capacity utilization rates, labor market slack, weak credit demand and, most importantly, negative consumer and producer prices inflation. Therefore, China's potential for growth should be higher than the 4.1 percent average growth in 2022-23. In our view, it should be in the 4.5-5 percent range. Growth could be even higher for a short period, if the economy can enter a cyclical rebound to close the negative output gap.
That cyclical rebound hasn't happened yet, primarily because after a prolonged property sector downturn and a sharp drop in inflation, a vicious loop has emerged among consumer spending, business profits and forward expectations for income and prices. A positive shock is required to break the loop. Unfortunately, both external demand and public spending have contracted for most of 2023, thus reinforcing rather than breaking this vicious circle.
Only the government can jump-start the economy through forceful and coordinated policy responses. The most important policy variable is the government's 2024 growth target. Our base case is the government will likely commit to boost growth by setting a growth target at "above 4.5 percent" for 2024, moderately higher than the 4.1 percent average growth in 2022-23. This will be consistent with our 4.7 percent real GDP growth and 1 percent inflation forecasts in 2024.
While the People's Bank of China will continue to ease lending conditions, to bring about recovery in the property market, more decisive fiscal policy support is necessary to see China's growth stabilizing at 4.7 percent in 2024, as per our forecast.
Fiscal expansion is the most effective policy tool to stimulate demand and boost prices in today's low-growth, low-inflation environment. The government finally changed its fiscal stance in Q3 by accelerating spending, helping local governments with their debt problems and, more recently, announcing stimulus packages for infrastructure investment and housing construction. It has also broken the long-standing 3 percent of GDP "glass ceiling" on budgetary deficits. We expect the fiscal stance will be 1.5-2 percent of GDP more expansionary in 2024, assuming the government will set a 3.8 percent of GDP fiscal deficit target, fully implement the 1 trillion yuan ($140.69 billion) infrastructure stimulus, and tap the PBOC's pledged supplementary lending facility for public housing projects.
Additional monetary easing is also warranted in 2024. We expect the PBOC to cut the medium-term lending facility rate by another 45 basis points before mid-2024 to bring bank interest rates below the natural rate. It will likely also cut the reserve requirement ratio by another 50 basis points, and inject liquidity through pledged supplementary lending and other long-term lending facilities, to make sure there's sufficient liquidity in the financial system to accommodate the upcoming fiscal expansion.
US/China growth dynamics and interest rate differentials will likely turn more favorable for the renminbi. The US economy is expected to enter a mild recession in the first half of 2024. The Fed is expected to cut interest rates by a total of 150 bps before year-end, 100 bps more than the expected cut by the PBOC. The renminbi will be supported by a sustained current account surplus and a reduction of capital outflows. We therefore expect the yuan will appreciate modestly by the end of 2024.
The author is China chief economist at Deutsche Bank. The views don't necessarily represent those of China Daily.
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