How worried is Beijing about the slowing economy, and what can it do to regain lost momentum while controlling risk? China watcher Osamu Tanaka provides a reader’s guide to the macroeconomic roadmap contained in the 2015 Report on the Work of the Government.

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On March 5, 2015, Chinese Premier Li Keqiang delivered the 2015 Report on the Work of the Government at the annual plenary session of the National People’s Congress. What light can the report shed on the government’s macroeconomic policies for the coming year? In the following, I provide an overview of the latest roadmap for steering the world’s second-largest economy as set forth in the official revised Work Report published on March 16.

Review of 2014 Policies

In its review of macroeconomic policy in 2014, the report stresses the government’s steady strategic focus in the face of mounting downward economic pressure. “Instead of using short-term stimulus measures,” it states, “we continued to develop new ideas and methods for macro regulation.”

The report reaffirms the government’s commitment to “range-based macro regulation,” an approach that Li Keqiang has emphasized ever since taking office. Range-based macro regulation rejects the use of powerful fiscal and monetary tools to stimulate or cool down the economy, providing it is operating within an “appropriate range.” Specifically, if inflation threatens to exceed the ceiling set in the Government Work Report, the government tightens the monetary and/or fiscal reins; if growth and employment begin to dip beneath that year’s target levels, it adopts easing and pump-priming measures. In this way, it seeks to maintain a strategic focus on the long-term goals of shifting to a new growth and development mechanism and adjusting the industrial structure instead of responding to each fluctuation in growth with quick-fix measures.

At the same time, the review of 2014 policy speaks of the use of “targeted regulation to keep the economy growing steadily.” Targeted regulation refers to fiscal or monetary policies tailored to the needs of specific sectors or actors in the economy. Included in this category are tax cuts targeted at small businesses and farmers, as well as the reduction of banks’ reserve requirement ratio. The government had frequent recourse to such measures in 2014.

Social and Economic Challenges

The 2015 Government Work Report acknowledges the economic and social difficulties and challenges China is facing. It identifies the issues below (italicized) and sets forth the government’s plans for addressing them.

Growth in investment is sluggish; the number of new areas of strong consumer activity is limited; there is no sign the international market is about to significantly pick up; maintaining stable growth is becoming more difficult, and there are still latent risks in some areas .

Year-on-year growth in investment in urban fixed assets was 15.7% in 2014, as compared with 19.6% in 2013, and the deceleration has continued into the current year, with growth in investment in the first two months up just 13.9% from the prior year period. To spur investment, the 2015 report calls for implementation of the following public works projects:

• Improving living standards by rebuilding rundown urban areas, renovating dilapidated housing, and upgrading urban underground pipe systems
• Building railways, highways, and inland waterways in the central and western regions
• Advancing agricultural programs focused on water management and farmland improvement
• Constructing major information, electricity, oil, and natural gas supply networks
• Promoting clean energy projects and projects to ensure stable supply of fossil fuels and mineral resources
• Upgrading traditional industries
• Implementing measures to conserve energy, protect the environment, and preserve ecosystems

The report indicates that investment in housing improvement and water management, as well as transportation projects, will be weighted toward the central and western regions. It also mentions the need to encourage private-sector investment and to channel private capital into more areas of the economy.

In the first two months of 2015, year-on-year growth in consumption was 10.7%, down from 12.0% in 2014. With this in mind, the report pledges to foster new engines of domestic demand in the form of elderly care, domestic services, health services, information goods and services, leisure and tourism, green products and services, education, culture, and sports, while at the same time working to keep housing demand stable. It also promises to move ahead with the construction of a single integrated broadband network to provide telecom services, cable television, and Internet access and to support the development of the logistics industry and door-to-door delivery services.

Prominent among the sources of economic risk is China’s shaky real estate market. While housing prices appear to be recovering in first-tier cities like Beijing and Shanghai, the glut of unsold homes in the provincial cities remains a serious concern. In response, the report promises to “support people’s demand for housing for personal use and second homes, and promote the stable and sound development of the real estate market.” Moreover, it omits the 2014 report’s reference to “reining in speculation and investment-oriented demand.”

Another area of lingering concern is the financial sector. Although the government succeeded in curbing the growth of shadow banking, defaults by Chinese companies are on the rise, and the ratio of nonperforming loans to total loans among the major banks has surpassed 1%. The government must also begin grappling seriously with industrial overcapacity and local government debt.

The prices of manufactured products are continuing to fall; the costs of factors of production are on the rise; small and micro businesses are finding it difficult and costly to obtain financing; and enterprises face increasing difficulties in their production and operations.

In 2014, the producer price index for manufactured goods fell by 1.9%, and the decline appears to be accelerating, with February 2015 prices showing a year-on-year drop of 4.8%. Falling crude oil prices account for much of this decrease, but the report also cites challenging business conditions as a factor. The government seems particularly concerned about the difficulties small and micro-sized businesses face in obtaining financing at a reasonable cost, and it has repeatedly marshaled fiscal and monetary policy in an effort to support such businesses.

While the version of the report initially presented to the NPC stated that “some enterprises face increasing difficulties in their production and operations,” the revised version strengthened the language by omitting the qualifier “some,” implying a more widespread problem.

China’s economic growth model remains inefficient; our capacity for innovation is insufficient; overcapacity is a pronounced problem, and the foundation of agriculture is weak.

Summing up China’s structural challenge, the report states that “as resource-related and environmental constraints grow and costs for labor and other factors of production rise, a model of development that draws on high levels of investment and energy consumption and is heavily driven by quantitative expansion becomes difficult to sustain.” It stresses that China is facing a triple challenge as it attempts to make difficult structural adjustments while countering downward pressures on the economy and addressing the adverse consequences of previous stimulus policies. For this reason, policy must aim at optimizing the economic structure while ensuring steady growth.

To this end, the government will implement a 10-year industrial plan for manufacturing industries referred to as “Made in China 2025” that promotes innovation to “upgrade China from a manufacturer of quantity to one of quality.” It will also continue to reduce overcapacity, encourage strategic mergers and acquisitions, and “let market competition determine which businesses survive.”

There are still many problems of public concern in medical services, elderly care, housing, transport, education, income distribution, food safety, and law and order. Environmental pollution is serious in some localities, and major accidents in the workplace are not uncommon .

In the report, the government promises to implement action plans for controlling air and water pollution. A commitment to “strengthen the prevention and control of soil pollution” was inserted in the revised version approved by the NPC.

There is still much to be improved in the work of the government, with some policies and measures not being satisfactorily implemented. A small number of government employees behave irresponsibly; shocking cases of corruption still exist; and some government officials are neglectful of their duties, holding onto their jobs while failing to fulfill their responsibilities.

The key challenge referred to here is the problem of government corruption. Numerous cases of malfeasance at the local level have come to light since the government launched its anti-corruption campaign with great fanfare.

Basic Economic Strategy for 2015

The report’s explanation of the government’s basic strategy for 2015 emphasizes the notion of a “new normal” and warns of new challenges in the coming year as the nation continues on the path to modernization amid slowing growth and an economy in need of structural adjustment.

It stresses that China has no choice but to pursue continued development while defusing economic risks in order to avoid the “middle-income trap” and achieve true modernization. “At the same time,” it notes, “China’s economic development has entered a new normal. Our country is in a crucial period during which . . . systemic, institutional, and structural problems have become ‘tigers in the road’ holding up development. Without deepening reform and making economic structural adjustments, we will have a difficult time sustaining steady and sound development.”

With these challenges in mind, the report states, “We must continue to promote development in a sound and balanced way through reform and speed up the transformation of the growth model so as to achieve quality, efficient, and sustainable development.”

The report warns that China is likely to face even greater economic challenges in 2015 than in the previous year as downward pressure on the economy builds and deep-seated structural problems surface. To cope with these challenges, it asserts, “We must strengthen our awareness of latent problems while remaining fully confident and taking an active approach to development.” It characterizes 2015 as a crucial year for advancing reform on all fronts and the first year in a new drive toward government based on the rule of law. In terms of the economy, it sees 2015 as a critical test of the nation’s ability to maintain steady growth while making needed structural adjustments. With these challenges in mind, the report sets forth the following basic requirements for government policy in 2015:

• Actively adapt to and guide the new normal in China’s economic development
• Adhere to the general principle of seeking progress while keeping performance stable
• Ensure that the economy performs within an appropriate range
• Focus on strengthening the quality and benefits of economic development
• Give greater priority to transforming the growth model and making structural adjustments
• Tackle tough problems of reform head-on
• Pursue innovation-driven development
• Strengthen risk prevention and control
• Strengthen safeguards for people’s standard of living
• Get the right balance between carrying out reform, pursuing development, and ensuring stability
• Promote all-round socialist economic, political, cultural, social, and ecological advancement
• Achieve steady and sound economic development and ensure social harmony and stability

Unlike the draft report presented by Li Keqiang, the revised version prefaces these with the more general requirement of acting “in accordance with the Four-Pronged Comprehensive Strategy” unveiled by Xi Jinping in February 2015. Also referred to as the Four Comprehensives, this strategy consists in comprehensively pursuing the goals of building a “moderately prosperous” society, deepening reform, governing according to the rule of law, and strengthening party discipline. (The initial presentation to the NPC also neglected to mention the government’s progress toward strengthening party discipline in 2014, an omission that Li Keqiang hastily rectified, calling it a typographical error.)

Macroeconomic Targets

The report calls for macroeconomic policies oriented to the twin objectives of maintaining “medium-high growth” and achieving a “medium-high” level of development, meaning manufacture of mid- and high-value-added products. It affirms the importance of maintaining policy continuity and stable market expectations even while pursuing reform and structural adjustment. It points out the need for “twin engines” of development in the form of entrepreneurship and innovation by the people on the one hand and growth in public goods and services on the other. And it stresses the need to maintain economic momentum despite adjustments in the growth rate and ensure that “growth in quantity is underpinned by greater quality” for a “more efficient, upgraded economy.”

The major macroeconomic targets outlined in the report are as follows (italicized):

Growth in GDP: about 7%

After a 2014 target of 7.4% and an annual growth rate of 7.5%, the 2015 report sets the more modest target of “approximately 7%,” explaining that the lower growth target “takes into consideration what is needed and what is possible.” It characterizes the target as compatible with China’s objective realities but also consistent with the goals of achieving a moderately prosperous society and expanding and upgrading the economy. “If China’s economy can grow at this rate for a relatively long time,” the report argues, “we will secure a more solid material foundation for modernization.” It also notes that “a 7% growth rate will ensure ample employment” as the industrial structure shifts toward services and the number of small and micro-sized businesses grows.

The economic report submitted to the NPC by the National Development and Reform Commission (NDRC) elaborates slightly on this explanation, noting that the projected growth rate “accommodates the new normal in economic development, reflects China’s current potential for economic growth, is in line with market expectations, and can be achieved with hard work.” It claims that economic growth of around 7% can be expected to create more than 10 million urban jobs, given trends in growth, structural change, and employment over the past few years.

While there was some talk of lowering the growth target in 2014, the proposal did not go through. This year, with the Central Committee of the Communist Party of China scheduled to deliberate the thirteenth five-year plan this coming autumn, the government doubtless saw the need to lower market expectations.

CPI inflation rate: about 3%

The 2015 target for inflation as measured by the consumer price index is below the 2014 target of 3.5% but higher than actual CPI inflation rate of 2.0%. Although the Government Work Report offers no particular rationale for the lower target, the NDRC’s economic report cites low international prices for major commodities and an ample supply of key commodities at home, as well as the “combination of overcapacity and sluggish demand” in some manufacturing industries. It adds, “We have also set this target to leave space for price reform.”

Some Chinese economists, meanwhile, have expressed concern that the economy could be heading toward a deflationary spiral and have suggested that a lower limit for inflation should be included among the indicators for range-based macro regulation.

Job creation in urban areas: at least 10 million new jobs

The target for 2014 was also 10 million urban jobs, while the actual number of new jobs created was 13.2 million.

Average registered unemployment in urban areas: 4.5% or lower

This is close to the 2014 ceiling of 4.6% but significantly higher than last year’s average urban unemployment rate of 4.09%.

Growth in imports and exports: around 6%

In 2014, the target was about 7.5%, but actual growth in trade amounted to only 3.4%.

Basic Thinking on Macroeconomic Policy

As guiding principles for continuity and improvement of macroeconomic policy in 2015, the report pledges to continue implementing “proactive fiscal policy and prudent monetary policy” while placing greater emphasis on proactive adjustment, fine-tuning, and targeted regulation. It promises to use existing and new financial resources effectively, targeting them to areas of weakness. “We will improve micro-level vitality to underpin macroeconomic stability,” it asserts, “explore new ways of achieving supply to boost demand, and balance total supply and demand through structural adjustments to ensure the economy performs within an appropriate range.”

More specifically, the report emphasizes the following directions for government fiscal and monetary policies.

Proactive fiscal policy: Strengthen investment to increase economic returns

The report projects a total budget deficit for 2015 at 1.62 trillion yuan (an increase of 270 billion yuan over the previous year), with the central government’s share estimated at 1.12 trillion yuan (up 170 billion yuan) and local governments’ at 500 billion yuan (up 100 billion yuan). This means that the ratio of public debt to GDP will rise to 2.3% from 2.1% in 2014, according to the report.

With the deficit growing, the report stresses the need to “find the right balance between managing debt and maintaining steady growth” and to “develop and improve mechanisms for local governments to secure financing through bond issuance.” It promises to ensure ongoing financing for sound construction projects already underway and to limit and defuse risk. It also pledges to continue making targeted tax cuts and across-the-board reductions in administrative fees to reduce the burden on businesses, particularly small and micro-sized enterprises.

At a press conference on March 6, Finance Minister Lou Jiwei noted that the projected debt-to-GDP ratio rises to 2.7% if one figures in allocations carried over from previous budgets and local government debt that is not included in the general account budget. In response to the problem of massive public debt at the local level, the Finance Ministry has decided to allow local governments to issue 1 trillion yuan in bonds to refinance a portion of the liabilities tallied up by the National Audit Office in June 2013. The bonds will be used to refinance about 54% of that portion of local government debt that matures in 2015.

Prudent monetary policy: Apply judicious combination of deregulation and oversight

With regard to monetary policy, the report promises to “strengthen and improve macro-prudential regulation, adopt a flexible approach in our use of monetary policy tools including open market operations, interest rates, required reserve ratios, and re-lending, and maintain steady growth in the supply of money and credit as well as aggregate financing in the economy.” It sets a target of around 12% for growth in the M2 money supply, down from last year’s 13% target (actual growth was 12.2%), while leaving the door open to slightly faster expansion, “depending on the needs of economic development.”

New Stimulus Measures in the Works?

Generally speaking, economic growth in the first quarter of the year is expected to be slower than in the previous quarter because public-works projects are not generally launched until the April-June quarter, after the NPC has officially approved the budget. In this case, however, a drop in growth would be worrying, given the relatively slow pace of growth in the fourth quarter of 2014.

To be sure, government statistics suggest a seemingly steady pace of 7.3% growth in both the third and fourth quarters of 2014, but these figures refer to the increase from the same period the previous year. Calculated according the method used by most advanced industrial countries, which compares each quarter with the previous one, China’s GDP grew by just 1.5% in the fourth quarter of 2014, as compared with 1.9% in the third quarter. A quarterly growth rate of 1.5% translates into an annual growth rate of 6%. If the figures for January-March 2015 show further deceleration, it could spell real trouble for the economy.

The government has already taken steps intended to avert such a slowdown. In February, shortly before the NPC convened, it implemented monetary easing measures, lowering banks’ reserve requirement ratios and reducing the benchmark interest rate for the second time since last November. At an executive meeting convened by Li Keqiang on February 25, the State Council decided to implement tax cuts and lower administrative fees “in order to support the development of small and micro-sized businesses to promote entrepreneurship and innovation.” It also approved a new water management project. On March 30, following the NPC plenum, the People’s Bank of China, the Ministry of Housing and Urban-Rural Development, the Finance Ministry, and the State Administration of Taxation issued statements announcing new rules easing requirements for certain home loans and exempting some home sales from business taxes in an effort to reenergize the housing market.

Meeting with members of the Chinese and foreign press on March 15, Li Keqiang stressed that because the government had refrained from implementing sweeping short-term stimulus measures over the past few years, it had ample room to maneuver in terms of managing the economy. “We still have quite a few tools in our toolbox,” he asserted, leaving open the possibility that the government could implement a new round of stimulus measures, depending on GDP results for the first quarter of 2015.