WB: China to adjust to a new normal

China’s growth continued to moderate reflecting renewed policy efforts to rebalance the economy. For 2015-16, average growth is expected to ease to slightly above 7 percent as policy efforts to place the economy on a more sustainable growth path are likely to intensify, according to the World Bank’s China Economic Update released.

“Policy efforts to tighten credit growth, reduce excess capacity, internalize the cost of industrial pollution, and harden budget constraints of local governments intensified in 2014. These policies are welcome and will help put growth on a more sustainable path,”says Karlis Smits, Senior Economist and main author of the Update.

Targeted support measures and the recovery of external demand have limited the slowdown, but the weak housing market remains a drag on domestic economic activity. The real estate sector, an important engine ofgrowth in recent years, continues to adjust to policies to tighten credit and reduce excess capacity. Largely due to weaker-than-expected domestic economic activity, the World Bank’s growth forecast for 2014 has been revised downward to 7.4 percent.

“The key short-term policy challenge is to strengthen market discipline in the financial sector. In the medium term, the challenge is to keep the reform momentum going," observes Chorching Goh, Lead Economist for China.

Especially important will be policies that facilitate the movement of resources from sectors with excess capacity, notably measures to gradually remove state guarantees and allow inefficient firms, including state-owned enterprises, to fail. This will require a careful balancing between enhancing market discipline and avoiding disruptions to the labor market. Over time, the role of administrative credit allocation needs to be gradually replaced with a market-based mechanism.

The China Economic Update, a regular review of China’s economy by the World Bank Group, indicates that the current emphasis on meeting short-term growth targets willmake it more challenging to implement the policies necessary to shift growth to a more sustainable medium-term path. Specifically, a focus on meeting an ambitious growth target would require more expansionary macroeconomic policies. In an uncertain global economic environment, China’s sizable policy buffers should be reserved to maintain overall macroeconomic stability in case of unexpected domestic or external economic shocks.