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China’s New Policies Less Credit Intensive

President Xi Jinping has repeatedly focused the reform process on enhancing state firms rather than on private firms and the market economy as a whole
The services sector is already creating more than 10 million jobs a year.The services sector is already creating more than 10 million jobs a year.

One of the benefits of China shifting its economy away from traditional manufacturing is that the country's economic growth will be less reliant on borrowing, an economist said on Monday.

"China is trying to boost growth of the new economy, as the new economy is less credit intensive. That's also helping deleveraging efforts in China," said Robin Xing, Morgan Stanley's chief China economist.

Speaking to CNBC on the sidelines of the Morgan Stanley China Technology, Media and Telecoms Conference in Beijing, Xing spoke against the backdrop of longstanding concerns about the sustainability of three decades of breakneck debt-fueled growth in the world's second-largest economy.

Morgan Stanley's GDP forecast for China is 6.5% this year. China's official 2017 growth target had been around 6.5%, and that's likely to remain unchanged this year, Reuters reported last Thursday, citing unnamed sources.

In 2016, China's growth was 6.7%, which was the slowest in almost three decades.

China has been fighting debt for years, but with little success so far as it balances economic stability against the fallout that would come from a sharp deceleration.

Growth Drivers

Last week, state news agency Xinhua reported China is planning to build a 13.8 billion yuan ($2.13 billion) technology park for the development of artificial intelligence. "If you look at all this new economy, it's all about connectivity, about productivity," said Xing.

A few years ago, six Chinese yuan (92 US cents) in debt generated 1 yuan (15 US cents) in GDP, but now it just requires 3 yuan (46 US cents) of debt to do the same, he added.

Xing said the contribution from consumption will continue to grow and the pace of growth for China's debt-to-GDP ratio is expected to mostly stabilize in the second half of 2019.

Already, the services sector is creating more than 10 million jobs a year, which is more than off-setting the cumulative four million job losses in old economy sectors such as machinery and steel, he said. Those industries have been witnessing layoffs due to an official crackdown on over-capacity.

There will "be lower risk, slower pace of growth, but better quality," said Xing.

Need for Strong Gov't Role

While China laid out several stated goals at its central economic work conference at the end of last year, including maintaining financial stability, reducing poverty, and improving the environment, the biggest unstated economic outcome that can be expected in 2018 is continued strong government involvement in the economy. This comes with a host of problems as marketization of the economy is stalled, Forbes reported.

Stronger government presence will be found in three major areas, based on past experience:

State Owned Enterprises

President Xi Jinping has repeatedly focused the reform process on enhancing state firms rather than on private firms and the market economy as a whole. Central state owned enterprises, which often dominate their sectors, are being strengthened rather than weakened, with private capital going to support government-associated firms rather than to expand private sector competition.

This will allow the government to continue influence economic outcomes and monopolize certain areas of the economy that it views as strategic such as the power, petroleum, railway and telecommunications sectors. Many Chinese SOEs are also expected to be engaged in outbound mergers and acquisitions, particularly on China’s flagship One Belt One Road.

Financial Markets

During Xi’s first term, a large amount of government intervention in financial markets was seen. The biggest example is government interposition in the stock market crash that began in the summer of 2015. Regulators attempted to stem the rout by purchasing shares, injecting funds into the market, and imposing a selling ban on major firms.

A circuit breaker mechanism was also implemented to halt trading when shares values fell to a certain point. Government intervention is also present in the property markets; when home prices rise or fall outside of a target range, local governments are directed to step in and change home buying policies.

Capital Controls and Exchange Rate

China attempted to liberalize its exchange rate in 2015 as a step toward internationalizing the renminbi with the introduction of the China Foreign Exchange Trade System RMB Index to reflect the RMB movement against a basket of currencies, with greater transparency.

This was reversed when the central bank announced that it would introduce a “counter-cyclical” factor into the exchange rate calculation last year. Capital controls, which appeared to be shrinking in recent years, were tightened at the end of 2016 in order to maintain the value of the RMB, as depreciation pressures grew. These controls have been extended to restrict particular types of outbound direct investment to reduce capital flight through fraudulent international transactions.

As China continues to experience a slowing economy and high levels of corporate sector indebtedness, officials will no doubt display strong control over the exchange rate via exchange rate valuation and the capital control regime through 2018.

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