The Blog of Changes - Duncan Freeman

China Breaks the Mould

The Shanghai interbank lending rate (SHIBOR) has hit record highs in recent days, making headlines and causing a degree of shock around the world. While the government’s squeeze on interbank lending is a bold move by China’s new leadership, it is not entirely out of the blue. In recent months the leadership of Xi Jinping and Li Keqiang has shown itself ready to break the mould on a number of issues.

The issue of fixed asset investment is illustrative. As the Blog of Changes has noted previously, fixed asset investment in China has followed the same pattern under every previous leadership generation since the 1980s. In every case there has been a rapid increase in fixed asset investment growth rates after the new leadership comes into power, followed by a decrease.

Chart 1: China Fixed Asset Investment Monthly Year-On-Year Change (%) With Six Month Moving Average

Since Xi and Li came to power, they have resisted any temptation to go for growth by raising fixed asset investment. The chart shows the monthly year-on-year increase in investment from 2002 to May this year. The rise in fixed asset investment growth rates in the early part of the leadership of Hu Jintao and Wen Jiabao is clear. Already in the early months of 2003 it was on an upward trend, and reached a peak in 2004. It should be noted in passing that the so-called surge of investment initiated by the government stimulus programme after onset of the crisis in the US and Europe was in fact more of a small ripple than a wave, as the increase in growth rates was well below previous peaks. (In the early 1990s under Jiang Zemin they peaked at over 90%).For our purposes the most important figures are those of the past few months. As can be seen, fixed asset investment growth has been steady at about 20%, which in Chinese terms is slow. In April and May the increase fell below 20%, and the six-month moving average shows that investment is currently increasing at almost its lowest rate in a decade.

This, it should be remembered, is happening in a period when China’s economy is growing at its slowest rate since 2009 at the height of the crisis in the US and the EU. China’s response then was economic stimulation The new leadership is not taking the traditional way out by reverting to an expansionist investment boom. Thus, they had already indicated their intentions. The SHIBOR squeeze confirms them. As Li Keqiang said last week, and was confirmed subsequently by the People’s Bank of China, the government will not be resorting to expansionist policy to boost growth. Outside China, this has caused some consternation. Decreasing growth rates and no attempt to support them with short-term measures were not what was expected even though the government has signaled its intentions. However, there is a widespread expectation in China that the government is willing to let the growth rate fall to 7% before intervening. The government believes that the slower growth rates presents an opportunity to push forward reform. It is expecting a reform dividend to restore growth rather than the resorting to past methods that are bringing increasingly smaller returns on investment.

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