Premier Li Keqiang delivered the government work report at the NPC session on March 5. On the basis of our earlier preview of the NPC & CPPCC sessions (see Policies hold the key to growth, published on February 22, 2016), our further interpretations of the government work report and macro policies are as follows:

The economic growth target has a lower limit; the central government’s intention to support growth becomes clearer. According to the government work report, the government lowered its 2016 GDP growth target to 6.5~7% from 2015’s 7% as expected, and kept the new urban employment target unchanged at 10mn people (Figure 1). This is the first time the government targets a growth range. With the growth under increased downward pressure, it is a practical and realistic choice for the government to lower its growth target; otherwise, if the government sticks to a 7% growth target, it might miss its target for a third consecutive year since 2014. Targeting a growth range also shows that there is a lower limit for growth. At a time when the growth momentum remains weak, this can send a clear pro-growth signal to the market, thereby enhancing the confidence of economic participants and helping bolster growth. This can also provide a stable macro environment for reforms and structural adjustment. The growth-stabilizing policies, if implemented effectively, could lend some support to the economy. We maintain our 2016 GDP growth forecast at 6.8%, higher than the market consensus of 6.5%.

Macro policies become more proactive. Monetary policy will be further eased and in particular, fiscal and quasi-fiscal policies will play a greater role. Although monetary policy has been less effective in stimulating economic growth, appropriate monetary easing is still necessary in the current deflationary environment. The government work report set this year’s M2 growth target at 13%, 1ppt higher than last year’s. In particular, the government announced a total social financing (TSF) growth target of 13% this year, which translates to an incremental TSF target of Rmb18trn, vs. last year’s actual figure of Rmb15.4trn. Considering the amount of local government debt swap this year (estimated at Rmb5~6trn) will be much larger than last year (Rmb3.2trn), the actual incremental TSF this year will be even larger. Overall, market interest rates are expected to fall further in a relatively favorable monetary and financial environment. Premier Li proposed to keep the renminbi exchange rate basically stable at a reasonable and balanced level. Learning the lessons of the exchange rate reform in August 2015 and the sharp exchange rate volatility in early 2016, the central bank will manage the renminbi exchange rate against the US dollar and pay more attention to its stability to avoid the formation of depreciation expectations.

Fiscal policy and quasi-fiscal policy will be more expansionary. With monetary policy becoming less effective, expansionary fiscal and quasi-fiscal policies will play a bigger role in boosting economic growth. The need to increase government spending and promote infrastructure investment has increased. Fiscal policy will be more expansionary judging from the budget deficit target. The government raised this year’s budget deficit ratio target to 3% from last year’s 2.3%, setting this year’s budget deficit at Rmb2.2trn (central government deficit Rmb1.4trn, local government deficit Rmb780bn). Taking into account the idle public sector savings to be used, we expect the actual fiscal deficit ratio this year to exceed 4% and may even reach 4.5% (3.5% last year).

Quasi-fiscal policy will also be stepped up. The issuance of special bonds by policy banks to support infrastructure investment this year is expected to more than double last year’s Rmb800bn. As infrastructure projects funded by the special financial bonds also require financing via bank loans, the boost to the economy will be even larger. In addition, the government work report proposed to reduce the tax burden on enterprises, and cut the taxes of the private sector by >Rmb500bn this year. The replacement of business tax with VAT in the financial, real estate, construction and consumer service industries will be implemented in May and the tax burden of small and micro enterprises will also be further reduced. The Ministry of Finance is expected to begin studying policies to lower manufacturing VAT, reduce corporate social security contributions, and rationalize the personal income tax. There is significant room for the tax burden of the corporate sector to decline. In addition, the reform to shift to price-based resource taxes will be expanded this year to promote economic restructuring.

Infrastructure investment is expected to play a greater role. As expansionary fiscal and quasi-fiscal policies will ease infrastructure funding constraints significantly, infrastructure investment will likely play a leading role in stabilizing economic growth, by boosting growth of related cyclical industries. We observed a large increase in the issuance of UDIC bonds in January this year to >Rmb160bn. We expect the issuance of UDIC bonds to rise significantly this year after falling to Rmb900bn in 2015 from Rmb1.5trn in 2014. According to the government work report, there is still large room for effective investment to improve infrastructure and people’s well-being and to promote industrial transformation and upgrade; a number of major projects included in the 13th Five-Year Plan (FYP) will be launched this year, and new urbanization and the Silk Road Economic Belt and 21st Century Maritime Silk Road strategies will also create demand for infrastructure construction. Specifically, we expect increased investment in municipal infrastructure, urban rail transit, parking lot and utility tunnel projects. Local governments may also become more active this year. The government work report proposed to improve the supervision and accountability mechanisms to prevent inaction and improve incentive and fault tolerance mechanisms to support innovations.

In order to stabilize consumption growth amid slower household disposable income growth, the government work report proposed to strengthen the basic role of consumption in driving economic growth. We expect the government to introduce pro-consumption policies, including tax incentives, financial support, more transfer payments and social welfare spending, and stronger poverty alleviation efforts.

The 13th FYP provides clear direction for economic transformation. According to Premier Li, the economy needs to maintain mid-to-high-speed growth in the 13th five-year period and the government targets an average annual growth rate of over 6.5% for the period. The 13th FYP focuses on innovation, new urbanization (urbanization rate based on the hukou population to rise from 37% in 2015 to 45% in 2020), green development, reform and opening up, and people’s well-being, basically in line with our earlier preview. It is worth noting that Premier Li stressed the need to give first priority to development in the 13th five-year period. Keeping economic growth at a certain level in the next five years should remain an important objective of the government. In addition, the government wants to vigorously push ahead structural reforms while expanding aggregate demand moderately, especially supply-side structural reforms to reduce ineffective and low-end supply, expand effective and high-end supply and increase the supply of public goods and public services. In the next five years, we expect China’s economy will achieve certain growth and more importantly will experience significant structural changes. The economy will gradually shift from investment-driven to consumption-driven growth, and both government consumption and household consumption rates will rise. In our preview report published on February 22, we expect consumption to grow at an average annual rate of 10.5% in the next five years, >2ppt faster than nominal GDP growth.

Considering the weak economic growth momentum, the implementation of supply-side reforms may be weakened. The government work report did not focus on supply-side reforms but mostly repeated the previously introduced policies about the reforms. As the government shifts the focus of economic policy this year to growth stabilization and the adverse growth environment is not conducive to the smooth progress of supply-side reforms, we expect the implementation of supply-side reforms may be slower than expected. On the eve of the Spring Festival, the State Council issued guidelines for resolving overcapacity in the steel and coal industries, proposing much lower-than-expected capacity reduction targets. However, reforms may be delayed, but cannot be absent. China must implement reforms in order to achieve sustainable economic development. In the medium term, we are still confident about the progress of reforms in China.