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Prof. Liu Yuanchun on China's Q1 economic performance
Fiscal policy, deflation, consumption, private sector, employment, real estate, etc.
However, the CPI and PPI numbers have raised concerns about possible economic deflation, casting doubts on the sustainability of this uptick in the economy.
Today's piece is a translated interview with Professor 刘元春 Liu Yuanchun, one of China's leading economic scholars. The interview was conducted by China Finance 40 Forum (CF40), a highly respected think tank in the field of finance and macroeconomics in China. Professor Liu shared his insights shortly after the release of the economic data for the first quarter, offering a valuable perspective on China's current economic landscape.
Liu Yuanchun is the President of Shanghai University of Finance and Economics, and former Vice President and Deputy Dean of the School of Economics of Renmin University of China. He has been selected as a distinguished professor of the "Changjiang Scholars Program" and a distinguished expert of the State Council.
On April 29, 2022, Professor Liu delivered a lecture on regulating and guiding the healthy development of China's capital market in accordance with the law at a group study session of the Political Bureau of the Communist Party of China (CPC) Central Committee. The readout from Xinhua says, "The political bureau members listened carefully and had discussions."
Additionally, Liu has participated in symposiums on economic development held by the premier of the State Council several times.
Liu Yuanchun (on the far right) delivered a lecture on regulating and guiding the healthy development of China's capital market in accordance with the law at the 38th group study session of the Political Bureau of the CPC Central Committee on April 29, 2022.
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In the interview, Professor Liu highlights that China's overall economic performance in the first quarter was better than expected, but there is a structural discrepancy between supply and demand.
He emphasizes that while this structural divergence and asynchronous recovery may be acceptable in the short term, macroeconomic policies must pay close attention to the endogenous contraction caused by the mismatch between supply and demand. This further underscores the need to expand domestic demand and implement front-loaded policies, so that China's economy can swiftly transition from the first stage of post-epidemic recovery, which involves the normalization of social order and monetary transactions, to the second stage, which focuses on profit and balance sheet repair.
Firstly, the rhythm and strength of fiscal policy can be moderately strengthened, particularly at the central level. New methods should be implemented to provide financial support to private enterprises and protect the operations of grassroots governments.
Secondly, private enterprises are still grappling with the sustained impact of the pandemic, and all market players are facing bottlenecks. This necessitates policy readjustment and repositioning from economic reopening to achieving full recovery. At this critical juncture, it is crucial to increase financial support, particularly through subsidies for small and medium-sized enterprises, rather than solely relying on tax and fee reductions.
Thirdly, it is crucial to adopt a strategic approach towards local government debt, considering the creation of a cut-off point to differentiate between old and new debts, similar to what was done in 2014. Additionally, there is a need to increase fiscal transfers to support grassroots operations.
Fourthly, targeted measures should be implemented to address youth employment. This may include establishing a special fund for college students' employment, such as providing employment opportunities as a form of relief specifically designed for college students. It also involves improving the employment environment in middle and advanced manufacturing industries, and increasing job opportunities that align with college students' employment goals and expectations.
A translation of the full-text interview transcript
Q1: Data released by the National Bureau of Statistics (NBS) showed that China's GDP grew by 4.5 percent year-on-year (YoY) in the first quarter. However, subset data revealed both strong and weak performance in different sectors. How do you assess China's overall economic recovery in the first quarter?
Liu: The overall economic recovery in the first quarter exceeded market expectations. The reasons for this are:
First, as China optimized its COVID response, China's social orders and transactions have been restored at a faster pace compared to Europe, America, and Southeast Asia. This has laid a solid foundation for economic growth.
Second, despite pessimistic views on the external environment and the real estate market, the first quarter saw a better-than-expected performance in exports and the recovery of the real estate market. According to NBS data, China's goods exports reached 5.65 trillion yuan, a YoY increase of 8.4 percent in the first quarter. Additionally, real estate development investment declined by 5.8 percent YoY, which is a contraction of nearly half compared to the end of the previous year. The area of sold commercial housing was 299.46 million square meters, down 1.8 percent YoY, narrowing the decline further. Among the housing areas, the number of residential housing areas turned positive, increasing by 1.4 percent YoY. The sales of commercial housing reached 305.45 billion yuan, a 4.1 percent YoY increase, with residential housing sales increasing by 7.1 percent.
Third, the local government started the year with full force to "gear up the economy" for a "grand start," and the positive outcomes of the government reshuffle were evident.
However, the recovery is not homogeneous across all sectors, and there are some structural features. For example, supply-side recovery is faster than demand-side recovery, service sector recovery is faster than secondary industry recovery. Most importantly, the recovery of state-owned enterprises is significantly faster than the recovery of private enterprises, and the recovery of large and medium-sized enterprises is faster than the recovery of small and medium-sized enterprises.
Under expansionary policies, the dividends of economic recovery gradually trickle down. This structural divergence and asynchrony of recovery are normal and acceptable in the short term.
Q2: In the first quarter, the CPI rose by 1.3 percent YoY, and the PPI fell by 1.6 percent. Recently, there has been widespread discussion about the possibility of deflation due to the weak performance of price indicators. What is your perspective on this? What are your expectations for inflation in China in the second quarter and for the entire year?
Liu: First, it is important to clarify that low CPI and PPI do not necessarily indicate deflation in the economy.
Second, the current low prices indicate an imbalance between supply and demand, but this imbalance does not necessarily signify demand contraction. Rather, it reflects a supply recovery that has outpaced demand, which can be attributed to the time lag in expansionary policies, particularly the relatively delayed impact of domestic policies on boosting demand.
Third, the core CPI (deducting food and energy prices) is a more reliable indicator for measuring the macro supply and demand situation. The decline in CPI prices can be largely attributed to food and energy price fluctuations, whereas the core CPI in March actually showed a YoY increase of 0.7 percent. This increase signifies a mild rebound compared to the period from January to February, rather than a decline.
Fourth, the decline in PPI is largely influenced by international commodity price fluctuations and base effects. For example, the conflict between Russia and Ukraine last year resulted in a surge in commodity prices such as oil, but recently oil prices have rebounded significantly. This has led to a strong impact on PPI due to the increased costs of imported commodities.
In general, the current decline in price indicators is seasonal, imported, and temporary in nature.
In the second quarter, with pork and other food prices reaching the bottom price and energy prices experiencing adjustments, we believe that the expansion of domestic demand will balance supply and demand, and prices will come out of the current state.
Within the whole year, the core CPI is expected to rebound from the current 0.7 percent to about 1.0 percent, and the overall price level is likely to rebound from 1.3 percent in the first quarter and stabilize in the range of 1.5 percent - 2 percent.
It should be noted that this year will certainly see a price rebound, but the rebound is still facing strong uncertainty, including uncertainty in food prices, and geopolitical fluctuations that may also impact commodity prices.
Q3: How do you assess the sustainability of the subsequent recovery of our economy? What is your outlook for economic growth in the second quarter and for the whole year?
Liu: I'm cautiously optimistic. The sustained rebound in China's economic growth is expected due to the base effect, which may result in a jump in YoY economic growth in the second quarter compared to the first quarter.
From a whole-year perspective, the trend of recovery is evident, but there may be fluctuations and iterations that complicate the recovery process. One significant factor is the time it takes to emerge from the shadow of the pandemic and to repair and expand the balance sheet. The outcome of this process will depend on the government's financial strength and policy sustainability.
Currently, China's macro policy still has ample room for maneuver, but there is a significant divergence among local governments, with debt issues constraining the expansion of some local policies. Additionally, addressing risks associated with the real estate industry remains a challenge. Furthermore, the external environment, despite foreign demand showing an uptick in the first quarter, still presents uncertainties regarding the possibility of another dip in the global economy in the future.
Q4: Total retail sales of consumer goods grew by 5.8 percent YoY in the first quarter. How much do you think consumption has recovered compared to the pre-pandemic period? How strong will the rebound in consumption be in the first half of the year and throughout the whole year?
Liu: If we break down the post-pandemic Chinese economic recovery into three phases, namely the repair of social order and monetary transactions, the repair of profits and balance sheets, and the normalization of balance sheet expansion, we can say that consumption has now recovered to the first phase. This means that the optimization of anti-virus policies has led to the normalization of social order and monetary transactions, and we can see the post-pandemic restart in travel and food consumption. However, the recovery of durable goods, especially those related to real estate, and the recovery of services still take time.
It's important to note that for consumption to fully recover and expand throughout the year, it needs to be supported by income growth and significant improvement in residents' balance sheets. This will require robust consumption policies and identifying favorable consumption scenarios.
Policy-wise, the government can first increase support for residential consumption, especially in the area of housing renovation, which can achieve multiple objectives. Firstly, Chinese residents are currently in the second round of the housing renovation cycle (a renovation cycle usually finishes a round in 12 years. If we start the calculation from the 1998 housing reform, it has already been 24 years, around the start of the second round of renovation), with a large number of homes needing renovations that are over 12 years old, or even longer. Through renovation subsidies, the government can promote noticeable consumption improvement.
Secondly, financial subsidies for the middle and low-income groups must be increased. Currently, it appears that the impact of the pandemic on the middle and low-income groups is still significant.
Thirdly, assessment and study are required to determine the focus of policy to promote the consumption of durable goods, such as cars.
Q5: In terms of investment, national fixed asset YoY investment grew by 5.1 percent in the first quarter, but private investment grew by only 0.6 percent, which is lower than last year's YoY growth rate of 0.9 percent. How do you assess the current situation of private investment, and what measures can be taken to boost private investment growth?
Liu: Private investment is closely tied to the overall conditions of private enterprises and their expectations for the implementation of the "two unwavering" policies, which are the "unwavering consolidation and development of the public economy" and the "unwavering encouragement, support, and guide the development of the private economy," in the medium and long term. The main reason why private investment did not restart well in the first quarter is that, although transactions have recovered to some extent, a significant number of private enterprises are still having low profitability and have not yet restored their corporate balance sheets. As a result, private investment expectations have not been fundamentally revised, and the impact of the epidemic on small and medium-sized enterprises is still felt.
After three years of the pandemic, market players may find themselves in a bottleneck state, facing the need for readjustment and repositioning from economic restart to full recovery. Achieving a complete restart of private businesses requires a gradual driving force. Currently, we can observe that social order is returning to normal and the economic cycle is restarting, albeit at a lower level. However, existing business activities may not be sufficient for many enterprises to fully recover from past losses and address their current capital shortages. In such a situation, it is crucial to increase financial support, particularly through subsidies for small and medium-sized enterprises, rather than solely relying on tax and fee reductions.
Currently, a significant portion of expansionary policies is primarily focused on government-led projects and investments carried out by state-owned enterprises. However, there may be a time lag for these investments to be transmitted from state-owned enterprises to private enterprises. In order to enhance the support of macro policies for private enterprises, new ideas are needed. Policies should find new approaches and move away from the traditional mindset of "ditch-digging in fiscal policy, excessive easing in monetary policy," meaning the government eases fiscal policy to stimulate economic growth by increasing spending or reducing taxes while the central bank uses monetary policy to inject excessive liquidity and credit availability in the economy.
To boost private investment growth, more direct measures are needed. Firstly, the government should increase support for small and medium-sized enterprises and the restart of the service sector. Secondly, the issue of divergence in corporate financing costs should be given serious consideration.
Firstly, the government should increase tax and fee reductions for small and medium-sized enterprises. The executive meeting of the State Council emphasized the continuation and optimization of preferential fees in a staggered order, such as continuing the implementation of policies that reduce the annual taxable income of small and micro enterprises and individual entrepreneurs up to 1 million yuan, as well as decreasing the unemployment and work injury insurance premium rate until the end of 2024.
Secondly, specific promotional policies should be introduced to support the recovery of contact-based services. The service industry is labor-intensive and plays a crucial role in stabilizing employment. While some essential service industry activities have already recovered, there is a need to improve the recovery of services related to spiritual well-being and entertainment. This requires the government to allocate special funds for these services.
Thirdly, targeted support should be provided for the financing of small and medium-sized private enterprises. Currently, the financing costs for state-owned enterprises are low, which has led to some arbitrage practices by state-owned enterprises. These practices are not conducive to the recovery of private enterprises.
Fourthly, expectations of private enterprises regarding their businesses have been regained, and these expectations need to be consolidated. Various facilities should be provided for repairing private enterprises' balance sheets and strategically positioning enterprises. In this regard, there should be other measures to boost green investment and optimize the institutional system.
In addition, the current fiscal drive is still hindered by the issue of local government debt. It can be observed that there is a clear disparity in the recovery among different regions, which is closely related to the local financial situation. In other words, despite the high motivation of everyone, some regions are held back by historical issues. Even with more planning, the actual impact may not be sufficient. This requires us to have a strategic understanding of local government debt and consider whether a cutoff of old and new debts, similar to 2014, is needed, as well as whether fiscal transfers are required to support local grassroots operations.
In 2020, a special national bond was issued to support grassroots operations. However, as of now, the special national bond has only maintained relative stability in grassroots operations for 2020, without establishing mechanisms and institutional arrangements to safeguard them. This year, despite local governments being highly motivated, their capacity to expand is not enough, resulting in negative month-on-month growth in fixed asset investment in the first quarter, especially in March. According to the National Bureau of Statistics (NBS), from January to March, national fixed asset investment (excluding farmers) was 10.7 trillion yuan, showing a YoY increase of 5.1 percent. However, this data was lower compared to the 5.5 percent YoY growth observed from January to February. From this perspective, new approaches are needed to support the functioning of grassroots operations and ensure effective expansion of local finances.
Q6: Regarding employment, the current unemployment rate for young people aged 16-24 remains high at 19.6 percent. What are the causes, effects, and responses to this unemployment rate among young people?
Liu: Since March, a large number of graduates have begun searching for jobs, and the unemployment rate among young people aged 16-24 has rebounded significantly compared to last month. The reasons for this rebound are that measures to stabilize jobs in the past few years have lagged behind the development, and the employment supply is higher than the demand, which has been overdrawn in previous years. The cumulative effect of these reasons has made this year's employment pressure greater than ever.
We therefore suggest that the government set up a special fund for college students' employment and create projects that provide employment opportunities specifically targeted towards college students. Traditional projects have mostly focused on migrant workers, but now the issue of employment for college students is more pronounced, and special measures are needed in this regard.
In addition, there should be an acceleration in the recovery of labor-intensive industries to improve the employment environment in middle and high-end manufacturing industries. Jobs should align with the employment goals and expectations of college students.
Unemployment among young people is not only an economic and social issue, but also a political one of high importance. It was also noted during the regular meeting of the State Council held on April 14, which was focused on the optimization and adjustment of policies and measures to stabilize employment. This meeting highlights that the employment issue has become a priority for the government, and various departments of the State Council have made corresponding arrangements to address these concerns.
Q7: Real estate development in the first quarter fell by 5.8 percent YoY, but the rate of decline narrowed significantly, and sales figures turned positive. However, real estate developers' funds in place fell by 9 percent YoY. How do you evaluate the recovery of the real estate market? What do you think about the momentum for a sustained recovery in the real estate market?
Liu: The recovery of the real estate industry follows a specific sequence, with sales recovery being the first step, followed by capital and investment. So far, the data shows that the sales performance has exceeded expectations, although the investment data has also shown a significant rebound. However, it should be noted that new housing construction started in the first quarter was down 19.2 percent YoY at 241.21 million square meters, and land auctions and other data indicate a relative slump. These conditions suggest that the overall recovery of the real estate industry may be relatively slow and prolonged.
The real estate sales data improved significantly in the first quarter, primarily due to the concentrated release of accumulated rigid demand over the past three years. It is expected that the overall real estate industry will show a gradual recovery in the future. After improved sales growth in the first quarter and adjustments and restructurings in the second quarter, real estate investment and the land market may experience significant recovery. However, there is also the possibility of retracements and fluctuations.
On one hand, the negative YoY growth of real estate developers' funds in place by 9 percent indicates that the balance sheet improvement of real estate enterprises has not been prioritized. It is expected that real estate developers may face some debt problems in the next stage. These events could impact the expectations for industrial recovery, and the real estate industry may face external shocks in the future.
On the other hand, following the path of past recoveries may prove to be challenging, as the underlying parameters and profitability models of the entire real estate industry have undergone significant changes. With the emergence of a new business model, leading real estate developers and the industry as a whole may require a longer time to reconstruct their businesses. Therefore, the recovery of the real estate market in the second half of the year could be complex.
Q8: In order to facilitate the economy to return to its normal growth trajectory, could you please provide a brief summary of your suggestions for the upcoming monetary and fiscal macroeconomic policies?
Liu: We must carefully consider the endogenous contraction resulting from the asynchronous recovery of both supply and demand. To address this, we need to implement policies that boost domestic demand and moderately raise the level of front-loaded policy. This will allow China's economy to transition quickly from the first stage of post-pandemic recovery, which involves normalizing social order and monetary transactions, to the second stage of profit and balance sheet repair through the expansion of domestic demand. I believe this should be the main focus of our current macroeconomic policy.
Another important policy focus is risk prevention and control. As the market environment normalizes, deeper hidden risks that emerged during the pandemic may come to light, demanding our utmost attention.
As for discussions on monetary policy, I believe that the current monetary policy is already very accommodating, and it may not be advisable to further increase monetary easing. Instead, fiscal policy can be moderately strengthened, particularly by the central fiscal departments. At the same time, we should have strong confidence in the solid foundation of China's economic recovery and the arrangements laid out by the Central Economic Work Conference.