China has a new No. 1 priority for its economy. It's not reform anymore, as the government announced last year, it's growth.
Out with the old, in with the old.
This shift is happening because the whole reform push was absolutely killing growth. Not just dampening it, as the government expected, killing it.
What's more, all of the tools China tried to use to prevent that killer — three interest-rate cuts since November as well as other policy measures — simply didn't work.
"Knowing that Beijing has not yet given up on economic growth, we are not surprised to see that its stance on fiscal reform is softening for the moment," Societe Generale China analyst Wei Yao wrote in a recent note. "The top priority has again shifted (temporarily) from reform to growth."
The problem here is that private-sector demand isn't making up for public-sector demand lost during this reform push.
So it's back to the old recipe for growth in China. Banks will start ramping up loans to fund infrastructure projects again (especially stalled state projects). Local governments competing with private companies for development projects will get preferential tax breaks again.
Local government funding vehicles (LGFVs) will start getting access to the bond market again even though that was put to a halt at the end of last year. Before China hung the LGFVs out to dry they made up a third of China's $2.5 trillion corporate bond market.
So you definitely don't want that to dry up.
Credit growth, in general, needs to continue at a steady clip for China to stay on track. When China needed stimulus really badly in 2009 (to the tune of $644 billion) it lowered interest rates, let state entities start handing out credit, and put a bunch of debt on healthy bank balance sheets.
Now China doesn't have the option of doing the latter two, according to Yao. There's too much debt on bank balance sheets, and they're not healthy enough to deal with more. As for state entities, the government doesn't want them handing out credit again. That would be too much of a reversal from this reform track.
So what we're going to get here is a bumpy ride where the Chinese government moves from reform to growth, growth to reform, to avoid a hard landing.
It's going to be tough, though. During bumpy rides things can sometimes spin out of control.
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