Yu Yongding on China's economy at CCG VIP Luncheon

The former central bank monetary advisor urges Beijing to expand monetary and fiscal policies and ramp up infrastructure investment. Long-term Govt bonds is "unusual" and "test case", he says.

The Center for China and Globalization (CCG), supported by Beijing International Club, held a CCG VIP Luncheon on Tuesday, May 14 centering on China’s economy.

The luncheon was held in the historic Xianhe Hall of the club and featured Yu Yongding, former director-general of the Institute of World Economics and Politics (IWEP), former member of the Monetary Policy Committee of the People's Bank of China; Zong Liang, chief researcher at the Bank of China Research Institute, deputy general manager of the Bank of China's Strategic Development Department, and the vice chair of the International Finance Institute of the Bank of China; and Henry Huiyao Wang, President of CCG.

Given Yu Yongding’s seniority and impact, this post shares an edited version of his speech and answers to several questions, which were transcribed from an audio recording. Let me stress the following is NOT a verbatim account. Neither the transcript nor the edited version have been reviewed by Yu.

Yu’s speech, edited

Recently, there has been a lot of discussion about the possibility of a crisis in China. Notably, Paul Krugman has suggested that the Chinese economy is "teetering on the edge of a crisis." With a career spanning over 40 years in economic studies, particularly in Chinese economics, my experience advises caution when predicting China's economic trajectory.

In my early career, I often predicted crises for China, foreseeing significant dangers ahead. For 20 years, this was a recurring theme in my observations. However, as I gained more experience and observed the unfolding economic developments, my views evolved. Since the mid-1990s, I have recognized the Chinese economy's extraordinary resilience. Despite facing numerous challenges, the economy has generally managed to sustain itself and progress. This revised outlook has proven correct repeatedly, enhancing my academic reputation. Therefore, my advice to those forecasting an imminent crisis in the Chinese economy is to proceed with caution, considering the potential impact on your academic credibility.

However, I must acknowledge that the Chinese economy has entered a new phase. The era of sustained double-digit growth rates is over. It is unrealistic for any country to maintain such high growth rates—around 10%—for decades. Therefore, the slowdown in the Chinese economy is a natural transition.

For instance, in the first quarter of 2010, China's growth rate was 12.2%. By the last quarter of 2019, it had decreased to just 6%. This significant reduction is subject to intense debate among Chinese economists. Some argue this slowdown was inevitable due to factors like aging demographics, diminishing returns of scale, and lack of reform. In meetings, I often presented a paper I authored predicting this slowdown, citing these factors, which usually garners applause. I then revealed that the paper was authored in 1998, after which China recorded its strongest growth. My point is while fundamental factors are influential, their exact impact on timing is unpredictable.

This scenario highlights the inadequacy of using long-term slow-moving variables to predict China's economic performance. A more effective approach is a detailed, item-by-item analysis. For example, understanding the components of aggregate demand, their growth rates, and their share in GDP is crucial for accurate economic forecasting.

Looking ahead to 2024, the question arises whether China can achieve a 5% growth rate. Based on current indicators, this is entirely possible, though challenging. For instance, last year, China's overall growth rate was 5.2%, with consumption growth at 8.2%. It's improbable for the consumption growth rate to remain at 8% this year due to the dissipation of last year's base effect.

My early prediction for this year is that the consumption growth rate will adjust to around 5%. If this prediction holds, it will significantly influence the overall GDP growth. Additional factors, such as investment growth and net exports, will also play critical roles in achieving this year's growth targets.

China’s economy is currently facing two major challenges: a reduction in the consumption growth rate and a continuing decline in real estate investment growth, which has been negative for the past few years. Assuming net exports remain stable, the critical factor will be whether China can maintain a robust investment growth rate, particularly in infrastructure.

According to my calculations, this year's infrastructure investment growth needs to exceed last year's, ideally reaching double digits. If the Chinese government does not adopt more expansive fiscal policies, achieving this growth rate will be challenging. Therefore, my policy recommendation is for China to increase its government budget deficit, which is already projected to be higher than usual at 3.8% this year. However, by international standards, such as those set by the IMF, China's so-called augmented budget deficit is considerably higher, around 8%. While this may be a cause for concern, it should not induce fear. For context, the United States had a budget deficit rate of 15% in 2020 and maintains about 5% currently.

In conclusion, compared to other countries, China's fiscal position remains relatively strong. Therefore, the Chinese government should confidently employ more expansive fiscal policies to finance infrastructure investment through additional government bonds. My strategy is a controversial, minority view in China, but it is essential for sustaining economic growth.

China’s Ministry of Finance is issuing long-term bonds which will serve as a test case. The successful issuance of these bonds, coupled with active support from the People's Bank of China, could play a pivotal role in achieving the necessary investment growth rates. If these measures are successfully implemented, achieving a 5% growth rate in 2024 should be well within reach, notwithstanding the inherent challenges.

However, the task is complex. The issuance of long-term bonds by the Ministry of Finance - a move uncommon in China - will be a critical test of market confidence and government policy effectiveness. If people are hesitant to buy these bonds, yields could potentially spike.

I believe now is the time for the Chinese banking system to demonstrate its strength and capability. The People's Bank of China should take an active role by enhancing its open market operations, akin to what some might refer to as quantitative easing. Regardless of the terminology, which I don’t care about, the central bank must create conditions that will stabilize the yield curve, thereby facilitating smoother government bond issues. Successful bond issuance and adequate funding for local governments and enterprises could be the key to boosting infrastructure investment to double-digit growth.

Yu’s answer to a question on the lack of confidence in China’s economy, edited

In this critical juncture, confidence is paramount. If we bolster confidence in China's economic future, we can expect increased spending and investment, which will help sustain our development goals. However, confidence is still undermined by external factors like the COVID-19 pandemic.

China's economic slowdown has been a gradual process evident since 2010, and more pronounced since 2013. This slowdown, manifesting both annually and quarterly, naturally impacts public and investor confidence. While fundamental and long-term causes exist, they do not fully account for the observed deceleration in growth rates. We must also consider sectoral, structural, and institutional challenges that require detailed policy attention.

China’s slowdown is policy-induced, at least in some aspect. Initially, China's approach focused heavily on stimulus measures, as seen with the 2008 four-trillion yuan package that spurred substantial growth in 2010. That was very successful. However, fears of inflation and economic overheating led to a rapid policy reversal, particularly in 2011, when inflation exceeded 5.6%, a level that both the government and the people found unacceptable, prompting the government to reduce its budget deficit drastically and slow down credit expansion.

From 2012 onwards, China has faced deflationary pressures, with the Producer Price Index (PPI) falling into negative territory repeatedly. The Consumer Price Index (CPI) has been very low in the past months. An expansionary fiscal and monetary policy could be beneficial, yet there has been, over the decade, considerable caution against exacerbating issues like real estate bubbles and high inflation.

The emphasis on reducing overcapacity has been a recurring theme in government reports for over a decade. However, the narrative is shifting towards addressing the lack of effective demand, which is now recognized as the most critical challenge facing China's economy. This shift marks a significant policy reorientation towards stimulating internal demand—a strategy vital for reviving and sustaining economic growth.

Deng Xiaoping famously said, "Development is the absolute principle." Following this principle, the primary goal now is to ensure that China not only stabilizes its growth rate at a manageable level, such as 5% but also that this growth is sustainable and benefits all sectors of society. Development and growth are the ideal conditions for strategic reforms to improve income distribution, enhance the social security system, and promote structural reforms that ensure long-term prosperity.

Yu’s answer to a question on overcapacity, edited

I must clarify that I'm not an expert in this area. For more detailed insights, I suggest consulting younger specialists at the Institute of World Economics and Politics of the Chinese Academy of Social Sciences, who have conducted extensive research.

First, overcapacity should be understood as a sector-specific issue, rather than a macroeconomic one. In capitalist economies, cyclical overcapacity crises are common. At the macro level, the real challenge is not overcapacity itself, but a lack of effective demand. If we manage to align peak capacity with increased demand, the issue is resolved. It's important to differentiate between macroeconomic and sectoral overcapacity.

At the sectoral level, overcapacity can naturally lead to price drops, followed by reduced production, and eventually, to shortages that drive prices up again. This cyclical process is quite typical. Currently, the electric vehicle (EV) sector is experiencing overcapacity, leading to intense competition among manufacturers. Some industry experts in China predict that this could lead to many local carmakers going bankrupt in the coming years, which would naturally rebalance the capacity.

This process shouldn't cause alarm. It's a part of the competitive landscape, including competition with China. A crucial consideration is whether China adheres to World Trade Organization (WTO) rules. Rather than attempting to hinder the leading competitor to gain an advantage, it's better to focus on enhancing one's performance.

I was disappointed by Janet Yellen's remarks regarding China's overcapacity. While I have great respect for her as an economist, I believe she should avoid adopting the rhetoric used by politicians.

Let me stress again the above is NOT a verbatim account, but an edited version. For a transcript

Transcript of May 14 CCG VIP Luncheon on China's economy

CCG will hold a series of similar luncheons featuring noted Chinese speakers in Beijing throughout this year.