Xi Doubles Down on Stability-First Slow Growth in China

In past cycles, any hint that the Communist Party’s lofty growth forecasts were under threat led to all-in stimulus. This time around, even with the Chinese economy headed for the slowest expansion in almost three decades—and with more space to cut interest rates than its global counterparts have—President Xi Jinping is doubling down on his stability-first strategy. There’s stimulus, but it’s moderate, even minimal, and that has big repercussions for the world economy.

“In the past, just at the first hint of uncertainty they would throw open the credit taps,” says Andrew Polk, co-founder of research company Trivium China in Beijing. “Now they realize that an extra percentage point of growth is not worth the damage that they’d do to their economy.”

In 2008, when the global financial crisis hit, China unleashed the mother of all stimuli. Five cuts to the benchmark one-year lending rate were accompanied by a 4 trillion yuan ($563 billion) stimulus package that triggered an avalanche of bank lending, most of it to local governments for infrastructure investment.

That set in motion one of the fastest accumulations of debt in human history, and that debt is still a weight on the nation’s economy.

Analysts date the policy shift to May 2016, when an article written by “an authoritative person” in the People’s Daily, the Communist Party’s mouthpiece, called levels of debt the “original sin.” The “fantasy” of stimulating the economy through easy monetary policy had created problems including an emerging property bubble, excess industrial capacity, and rising nonperforming loans, according to the article, widely said to have been written by Vice Premier Liu He, President Xi’s top economic adviser. It signaled a new path that leaders have largely stuck to even amid the uncertainty of an escalating trade and technology war with the U.S.

Instead of making more credit available, policymakers are striving to redirect lending away from deadbeat state-owned enterprises to smaller, more efficient private companies. They’ve also sought to reduce systemic risk by strengthening the regulatory system. People’s Bank of China Governor Yi Gang reiterated the policy at a press briefing in Beijing on Sept. 24: “We are not in a rush to roll out massive rate cuts or QE, like some other central banks.”

The result is an inevitable drag on growth. Industrial production in August grew at the slowest pace for a single month since 2002, while a price index of industrial products fell deeper into deflation. All of this means China’s slowdown is likely to be a headwind for global economic growth this year and next, Polk says. “The rest of the world will need to get accustomed to the idea that China will not offer a quick fix to its current growth malaise,” says Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong.

China is taking some steps to keep growth humming. The amount of cash banks must hold as reserves was cut this month to the lowest level since 2007, market interest rates have been guided lower, and bond issuance for infrastructure spending has increased. The government also has pledged to cut taxes for businesses and households by about 2 trillion yuan ($281 billion) this year in what it described as the largest ever fiscal stimulus plan for the country. “Though it seems as though China is a laggard in policy stimulus, and the narrative proclaims it, the reality is a bit less convincing,” says George Magnus, an economist at University of Oxford China Centre and author of Red Flags: Why Xi’s China Is in Jeopardy.

Compared with past spending binges, this stimulus is more targeted and calibrated. But it’s not without risk: The biggest danger is that the economy slows more than policymakers expect, resulting in widespread unemployment and a downturn that becomes hard to reverse. Leaders may then crank up stimulus, bringing about the very financial instability they aimed to avoid.

The leadership’s resolve may be tested sooner rather than later. With more stubborn trade and financial challenges, growth could tumble to 5.5% without stronger stimulus, says Louis Kuijs, chief Asia economist at Oxford Economics in Hong Kong. “The coming six months are going to be a litmus test,” he says. “I personally don’t think that China’s policymakers are willing to tolerate such a rate of growth, but let’s see.” —Kevin Hamlin

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