China: Policy Poised to Turn More Pro-Growth in 2012

China’s policymakers this week have signalled that economic policy will become more pro-growth in 2012, although at this stage they see no need to use the ‘big bazooka’. Hence all the tightening measures targeting the property sector, introduced over the past two years, will remain in place for now. It also appears that the Chinese government prefers easing fiscal policy to easing monetary policy.

In the coming months we expect the policy response from China to be monetary easing through cuts in the reserve requirement for commercial banks and some easing of fiscal policy. However, the force of the policy response in China will depend on how economic data develops in the coming months. While we have cut our GDP forecast for Q4 11 and Q1 12 we still expect GDP growth to improve in the coming quarters supported by easier fiscal and monetary policy.

On exchange rate policy, China repeats the message from the previous year of a “basically stable exchange rate, while continuing exchange rate reform”. Hence this message is consistent with continued appreciation, albeit the pace will probably slow. China is, in our view, targeting a free-floating currency by 2015.

At this stage China is not ready to pull out the big guns

Chinese policymakers on Wednesday concluded the important annual Central Economic Work Conference (CEWC), at which they agreed on a strategy for economic policy and the most important macroeconomic goals for 2012.

In the statement released in connection with the CEWC-meeting it is clear that the Chinese government sees increasing downside risk on growth and feels increasingly confident that it has been able to get inflation under control, although inflation nevertheless remains a concern. However, so far it is only a cautious move in the direction of a more pro-growth policy stance. The overall policy stance is still described as “prudent” monetary policy and “pro-active” fiscal policy, unchanged from the CEWC meeting in December 2010, when it was changed from “moderately easy” monetary policy and “pro-active” fiscal policy. The key word for the Chinese leaders in recent months has been “fine-tuning”, suggesting that it is mainly adjusting existing policies and is not yet ready to bring out the big bazooka. However, the statement also underlines that policy will have to be “flexible” and “forward-looking” suggesting that policy will be adjusted if the economy performs worse than expected in the coming months.

Fiscal easing preferred to monetary easing

The CEWC statement also suggests that the Chinese government intends to let stimulus rely less on monetary easing and more on fiscal easing. So far all the tightening measures introduced since spring 2010 targeting property will remain in place. This includes the higher down payment requirement for home purchase, mortgage loan restrictions and the introduction of property tax in some property taxes. It’s clear from recent statement that the Chinese government does not mind a minor decline in property prices and is even targeting it. Central government revenues have so far increased more than 25% in 2011 and have created space to increase spending. It appears that fiscal stimulus this time will be mainly based on affordable housing construction, tax cuts and increased social welfare spending and compared with 2008/09 will rely less on infrastructure spending.

Policy response to improve growth next year

In the coming months we expect the policy response to be at least another three 50 basis points cuts in the reserve requirement for commercial banks, in addition to some fiscal easing. Tax cuts for small and medium-sized companies have already been announced. We are moving closer to an interest rate cut, but at this stage we expect them to remain unchanged.
In light of the weaker than expected data in recent months we have cut our forecast for GDP growth in Q4 11 from 8.5% q/q AR to 6.7% q/q AR and Q1 12 forecast has been cut from 9.8% q/q AR to 8.0% q/q AR. However, in light of the policy response we have revised our GDP forecast for Q2 12 higher from 8.8% Q/Q AR to 9.6% q/q AR and Q3 12 from 9% q/q AR to 10.0% q/q AR (see top chart on front page). For 2012 as a whole our GDO forecast has been cut from 8.9% to 8.5%.

Status quo on exchange rate policy

On exchange rate policy the CEWC says that China will “keep the exchange rate basically stable”, while “continuing exchange rate reform”, is a repeat of the language that China has used on the exchange rate policy in recent years. Hence, this suggests no major changes in the exchange rate policy compared to recent years. It appears that fiscal stimulus this time will be mainly based on affordable housing construction, tax cuts and increased social welfare spending and compared with 2008/09 will rely less on infrastructure spending.