Overcoming growth risks with more relaxed environment

It is important that macro regulators and policymakers do not intervene too much in structural problems and tolerate more natural market-oriented failures because they are symbiotic with success in the ecology of market competition. In other words, ghost towns and great cities, overcapacity and bottlenecks, excessive debts and excessive savings are all the new normal in a dynamic and fast-growing market economy. As China's market matures, the good parts will expand at the expense of the bad parts. What the government needs to do is to provide the right platforms for facilitating structural changes, such as deposit insurance, bankruptcy mechanisms and negative lists, which are the right micro-tools for dealing with specific structural cases.

The role of monetary authorities in an economy such as China's should be narrowed down to basically two primary macro goals:

The first would be to keep China's inflation higher than that of the US (assuming the renminbi-dollar exchange rate is relatively stable), because China's real return, real growth rate and real productivity growth are much higher than that of the US, and the prices of non-tradable goods and assets in China still have a lot of potential to catch up with those in the US. So deflation should not happen at this stage of China's development unless the money supply is too tight. China should and can avoid either deflation or hyperinflation.

The second goal of China's monetary authorities should be to stabilize the real interest rate at a low but positive level, say about 1 to 2 percent over the medium and long run. This means nominal interest rates need to be a bit higher than the inflation rate. Since the adjustment of interest rates could easily lead to volatility in securities markets, it may be easier and more important for the PBoC to target and stabilize the medium- and long-term inflation rate between 3 and 5 percent by implementing a more flexible and accommodating money supply.

The Central Economic Work Conference held from Dec 9 to 11 made stable growth the top priority for 2015. This means the growth rate for 2015 is likely to be about 7 to 7.5 percent. It also means overall macro conditions in 2015 should be more relaxed than in 2014, because a more relaxed macro environment is crucial not only for arresting the PPI deflation but also for offsetting the austerity effects of many structural and micro reforms such as the anti-corruption campaign, State-owned enterprises reform, and regulations on land use and the environment.

With the lagging effects of macro policy, China's real economy is likely to continue to grow slowly for a few months before more aggressive macro relaxation measures, such as the lowering of reserve requirement ratios for banks, are put in place. In the meantime, reforms toward financial deepening may be expedited given the authorities' strong intention to deleverage the banking sector, promote the internationalization of the renminbi, and encourage the development of the bond and securities market.

The new normal could well see the authorities trying and managing growth risks by implementing many substantial and systemic reforms at the structural and micro level as well as by promoting financial deepening.

The author is senior fellow and vice-president of Fung Global Institute.