The following is an excerpt from a research piece originally published on Roubini.com.
The risk of a sharp slowdown in China remains elevated and will rise in the medium term as financial liberalization contends with the legacy debts from unproductive local government investments and excess residential real estate construction.
Our baseline scenario calls for China to launch a partial bailout/restructuring of local government debts in 2014, causing a gradual contraction of infrastructure investment by end-2014. Most local government financial vehicles (LGFVs) will manage to avoid default, although the government may force some smaller entities into bankruptcy to reduce bailout-related moral hazard.
Growth should only slip to about 6.5-7.5% over the next few years amid gradual local government deleveraging and relatively stable property investment. The financial system is likely to come under strain in the medium term, but the probability of an acute financial crisis appears low under these conditions.
The major 2014 economic targets laid out by Chinese policy makers at the start of the National People’s Congress (NPC) offered no surprises. Premier Li Keqiang announced that China’s growth will remain “around 7.5%” once again in order to “boost market confidence and promote economic structural adjustment.” The targets for inflation and M2 growth were also left unchanged at 3.5% and 13%, respectively, implying continuity in monetary policy. Similarly, the Ministry of Finance’s budget report did not make any waves, calling for the fiscal deficit to hold steady at 2.1% of GDP. We maintain the forecasts presented in our latest China Outlook, published just before the start of the NPC.
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