Difficult choices ahead as nation revamps economy

Structural reforms will support a sustainable growth model and lift the country into the ranks of developed nations

It's all about trade-offs in the world of economics. Ideally, China would maintain its high growth while pushing steadily ahead with structural reforms, revamping its growth model and eventually making the jump that Japan and Singapore made from developing to a developed countries.

China has been facing major challenges since a broad reform agenda was announced during the Third Plenum of the 18th Central Committee of the Communist Party of China in November. The agenda aims to put China on a sustainable path of growth.

It's widely believed the economy expanded at its slowest pace in the first quarter this year since 2009. The consensus among economists is that GDP increased 7.2 percent year-on-year, the minimum level that Premier Li Keqiang has said is needed to ensure the creation of 10 million jobs annually.

The first-quarter GDP figure is due for release on Wednesday.

In China, employment has absolute priority: Leaving tens of millions of migrant workers idle could easily foster social unrest, which is the last thing that Beijing wants to see. So it all boils down to a simple choice: Stimulate growth to create employment, which runs counter to the policy of deleveraging, or stick closely to the reform agenda and risk a further slowdown.

Difficult choices ahead as nation revamps economyElsewhere, the choice may not be as hard. Reforms don't necessarily translate into a slowdown everywhere. But, in China, a reform-induced slowdown seems inevitable because much of the reform centers on ending excess investment and industrial overcapacity. Those are just the things that previously powered higher reported economic growth rates.

Two years before the key Party meeting, rebalancing efforts had already pared some 3 percentage points off China's expansion rates. GDP growth was 10.3 percent in 2010.

There is little doubt that the proposed reforms, if fully implemented, will boost productivity in the long term, but there are some short-term costs, said Zhang Qi, a Shanghai-based analyst with Haitong Securities Co Ltd.

In his annual Government Work Report in March, Premier Li made it clear that a growth rate that is too low is unacceptable.

"Growth is the key to all the pivotal issues in our country. We have to hold firm to the focus of economic development in our work and maintain a proper growth rate," Li said.

In the first two months of the year, industrial output growth was just 8.6 percent, the lowest since the global financial crisis in 2008.

Electricity production, which is widely believed to be the most accurate economic indicator in China, expanded only 5.5 percent in January and February, compared with 8.3 percent in December 2013.

China has prepared a contingency plan to protect growth. The recent acceleration in project approvals and construction has been perceived in the markets a sign of a mini-stimulus.

Investors are becoming increasingly concerned that China is reverting to its old ways and abandoning ambitious plans for reforms.

Central bank figures released on Tuesday showed that total social financing in March was more than the 1.85 trillion yuan ($297 billion) consensus, coming in at 2.07 trillion yuan, up from an average of 1.76 trillion yuan for January and February.

Many analysts took that figure to mean the central bank might have taken a looser stance on money supply.

The 1.05 trillion yuan in new loans for March also beat the market consensus of 1 trillion yuan.

Wang Tao, head of China Economic Research at UBS Securities AG, said China can hit two birds with one stone, at least in the near term.

"Keeping reform on track and protecting growth are not necessarily contradictory in the near term, and any support provided for growth this time will be intertwined with reforms as well," wrote Wang in an April 9 report. "Indeed, material progress has been made on reforms since November, and more will come."

Wang said that China has sequenced reforms in such a way that anything affecting growth will come later. Easier reforms such as opening up of the service sector to private investment and relaxation of the hukou (household registration system) and one-child policies will proceed more quickly.

Harder reforms, such as tougher local government budget constraints, restructuring of State-owned enterprises, launching a nationwide property tax system and land reforms, will progress more slowly, according to Wang.

"While such a sequencing of reforms may not be ideal and could heighten the risks associated with continued rapid growth in investment and leverage in the long run, in the near term it does help to stabilize growth and is the more feasible approach," she wrote.