Bernstein strategist Michael Parker on why China's Premier is between a rock and a hard place

The Chinese Premier is sensibly easing back on the emphatic “growth” speak we’ve heard from Chinese officials over recent years, without going so far as to committing a political faux pas by disregarding the ambitious targets laid out by his predecessors.

This is how Bernstein strategist, Michael Parker, has interpreted the Government Work Report Premier Li Keqiang delivered at China's annual rubber-stamping parliament on Saturday.

When discussing China’s latest Five Year Plan (2016-2020), Li said, “We should work to maintain a medium-high rate of growth” (English translation).

Unlike China’s former premier Wen Jiabao, who in 2012 said, “We have to set a target of 7% annual increase in the economy over the next five years”, Li didn’t mention any explicit numerical targets.

Parker dubs Li’s statement as “vague enough that anything short of a recession qualifies”.

“You can make the argument that the Chinese government has embarked upon an incremental shift away from long term growth targets while acknowledging the legacy commitments that the previous administration made,” he says.

The cost of achieving growth of 6.5% over next five years

Parker goes on to explain:

“In November 2012, then General Secretary Hu Jintao announced that China should double its 2010 GDP by 2020. That required China to grow 7% annually for the entire decade. China's GDP growth was 7.7% in 2012 and averaged 7.8% from 2011 to 2015.

“To achieve Hu Jintao's bombastic target, growth from 2016 to 2020 has to average 6.5%. Yet China cannot grow 6.5% for another five years without a reacceleration in borrowing and fixed asset investment.

“Credit efficacy and returns on incremental assets are already at historic lows. The Chinese consumer is in pretty good shape but mandating 6.5% real GDP growth while the economy transitions to services (and parts of the industrial sector are in recession) requires mid-teens growth in consumption for another five years. That's simply not happening.”

The impracticality of setting numerical growth targets in a services economy

Parker says a services-dominated economy cannot set growth targets for itself.

“In an economy where 90% of economic growth comes from services and where a large proportion of those services are purchased by consumers over their phones, dictating growth targets doesn’t make a lot of sense,” he says.

Parker maintains that if you are going to target growth in a services economy, it has to be achievable and not undermine the long-term health of an economy.

“Chinese GDP growth has been decelerating since 2010 when real GDP growth was 10.4%. Between 2010 and 2015, GDP growth fell 350bps,” he says.

“To meet an average growth rate of 6.5% through 2020, GDP growth can decelerate by no more than 80bps over the next five years.

“Li's dual goals to "finish building a moderately prosperous society" and "address serious issues such as unbalanced, uncoordinated and unsustainable development" appear to acknowledge qualitatively these constraints.”

Achieving consumption levels necessary to maintain 6.5% growth a ‘tall order’

Realistically speaking Parker says neither the industrial nor the agricultural sectors are going to be much help driving the economy, so a GDP growth rate of 6.5% is going to require nominal growth in the services sector of around 15%.

With wage growth at 8-10% annually, Parker admits achieving the necessary consumption growth will be a tall order.

Furthermore, he says China will have to stimulate some part of the economy to maintain a growth rate of 6.5%, as this won’t happen organically.

“This stimulus would come at a cost. And it will involve borrowing and investing in new capacity that China doesn’t need and cannot really afford,” Parker says.

Expect to hear less about ‘doubling the economy’ and more about ‘balancing development’

He concludes, “Arguably, the current administration is economically sophisticated enough to realize that once an industrialized economy transitions to services, growth rates slow and there is no option to turn back the clock.

“That is doubly true when debt levels have already spiked and problems with debt servicing capabilities are rising.

“At the same time, the current administration is certainly politically sophisticated enough to realize that you do not contradict the previous political leadership at one of the most high profile political event since the political transition in 2012.

“If these are the constraints the present administration is operating within, China will claw out 6.5% growth – or thereabouts – this year and we will hear a lot less about the doubling of the economy and a lot more about balancing, coordinating and sustaining development.”

Parker says “hope” “expect”, and “should work” is language of “a government observing a services economy, rather than commanding an industrial economy”.

“It is the difference between passive and active management. As a signal, it is a step back from Soviet style mandated targets.”