Lower growth target creates possibility of reform in China

• In line with its efforts to grow a high-quality economy, China lowered its GDP growth target for 2018 to advance its economic structural reforms.
• The government also aims to maintain a stable job market and consumer inflation, reduced the deficit-to-GDP ratio, and cut taxes for businesses and individuals. Investment in heavy industry and the transportation sector has declined.
• Growth momentum is expected to moderate in 2018 as a result of tightening monetary policy and slowing fiscal stimulus; consumer market may remain relatively robust.

China’s GDP growth target has been set at around 6.5% for 2018, as revealed by Premier Li Keqiang as he delivered the government work report to the 13th National People’s Congress (NPC). The 6.5% GDP growth target is unchanged from the 2017 target but lower than the 6.9% real growth achieved in the previous year, reflecting an increased focus on the quality rather than the pace of growth. Moreover, the 6.5% target remains higher than 6.3%, which is the minimum average annual growth required from 2018 to 2020 to meet the government’s goal of doubling GDP from 2010 to 2020. That is to say, China has plenty of room to implement its supply-side structural reforms in 2018.

Although the deficit-to-GDP ratio has been lowered to 2.6%, the fiscal shortfall is expected at the same level as in 2017 while expenditure is forecast to increase modestly focusing on supporting economic structural reform, specifically innovation, agriculture, and the people’s livelihood. The lowering of the deficit target does not imply tightening fiscal policy, but fiscal stimulus will continue to ease marginally given China’s efforts to rein in local government’s debt and stabilise macro leverage. Nonetheless, the government also plans to lower taxes and fees on businesses and individuals. Measures will include raising the individual income tax threshold for the first time in seven years, allowing children's education fees and critical illness medial expenditure to be deducted from individual income tax, and cutting value-added tax rates in the manufacturing and transportation sectors.

The government makes no mention of a concrete M2 or total social financing (TSF) target in the report, instead stating that money supply will be properly managed and that rational growth in the broader M2, lending, and TSF will be maintained. These changes signal that the regulators’ main target will be the prevention of financial risk in the next few years and the central bank will shift monetary policy from quantitative tools towards price-based tools following rapid development of financial innovations. Tightening of regulations about shadow banking is expected under the deleveraging campaign.

Although the CPI target has been set at 3.0% over recent years, consumer prices rose at average rate of only 1.9% over the past five years; in 2017, the CPI rose 1.6% year on year. Despite an upside risk to CPI in 2018, driven by a rising food price cycle, overall inflation remains unlikely as the Producer Price Index (PPI) has entered a downward trend, easing inflation pressure from upstream sectors. Therefore, the CPI may not intensify monetary tightening this year.

Investment will continue to shift away from traditional heavy industries. The government will also continue its campaign to cut overcapacity as part of its supply-side reforms, albeit at a smaller scale. According to the report, 50 million tonnes of steel capacity, 150 million tonnes of coal, and 50 million kilowatts of coal electricity capacity are planned to be cut in 2018, which may hurt investment in the mining, utilities, and ferrous metals sectors. Moreover, tighter regulations on government financing and increasing supervision on public-private-projects will drag on infrastructure investment.

The moderation of growth target will leave room for the country’s reforms to improve the quality of growth. The lowering of the growth target was expected and reaffirmed President Xi Jinping’s statement that China has entered a phase of “high-quality development” after decades of high-speed growth. Easing fiscal stimulus, tax reductions, tightening risk controls in financial institutions and intensifying supervision over shadow banking, further capacity cuts in heavy industry, and continuous regulation tightening in the property market will further advance China’s supply-side reforms in 2018, helping to resolve the structural problems that exist in China’s economy. Unless the moderation threatens the job market, the government is unlikely to increase stimulus to drive growth this year. IHS Markit expects China's GDP growth to slightly slow to 6.7% in 2018, with a moderation in the first half and a pick-up in the second half.