China and Brazil Look to the Future

China’s growth objective takes the driving seat

China’s National People’s Congress (NPC) completed its 2016 meetings in March, and unsurprisingly, growth was at the top of the agenda. The growth target was set at 6.5%–7.0%—a range that ensures that the current leadership delivers on the previous leadership’s promise to double incomes by 2020. To halt the multiyear growth slowdown, the authorities will pull a number of levers to make funds available for infrastructure projects and to support the housing market.

The leadership also hinted at supply-side reforms and acknowledged the need to tackle the excess capacity issues. Unfortunately, the reform objectives appear to have been subordinated to the growth objectives, and over the short term, the two are incompatible. One of the admirable goals of the supply-side reforms is to turn large, inefficient, and unprofitable state-owned enterprises into efficient, profitable businesses by revamping management practices and reducing the tax burden. But judging from the sound bites from the NPC, we should not expect too much progress on the efficiency front in the immediate future.

With regard to excess capacity, the Chinese leadership has a problem in that shutting down coal mines and steel mills will lead to rising unemployment. The problem here is less to do with the overall level of employment than with the concentration of unemployment in specific regions. As always, in China, social stability is the sine qua non, and concentrated unemployment leads to discontent and protests. The communication from the NPC suggests that the leadership is unwilling to run the risk of rising unemployment, and consequently, progress on capacity reduction in the heavy industries will be gradual.

Given the emphasis on supporting growth, we should expect activity indicators to show some signs of stabilization over the coming months. And although any growth bounce is unlikely to be long lasting, it could still alleviate some of the market’s fears about a hard landing in China. The big question is whether the market will be fooled into thinking that all is well as China ventures into another credit-fueled stimulus program that compounds the imbalances of the economy or whether the market looks through the near-term growth data and focuses on the longer-term challenges. My guess is that improving growth data will provide enough short-term comfort for markets and support risk sentiment.

No short-term fix for Brazil

The Brazilian financial markets have staged an outsized rally over the past few months. In part, this has been driven by improved global risk sentiment and by an important (though temporary?) improvement in the terms of trade. However, the rally also reflects the fact that the corruption scandal that has plagued the country for the past 18 months or so is rapidly progressing toward its apex. The regime of the Workers’ Party is crumbling as the corruption scandal has exposed a political system that is corrupt to its core.

By appointing former President Lula da Silva as her chief of staff, current President Dilma Rousseff hoped to garner enough support in the lower house to quell the growing threat of impeachment. It seems unlikely to work: The evidence appears overwhelmingly unfavourable to the president, and a change at the helm of the government is likely. However, while impeaching the president would remove some of the policy paralysis that has kept the country captive over the past 18 months, it is unlikely to bring about conditions under which badly needed structural reforms can be implemented; the tentacles of corruption spread throughout the Brazilian political system, and the investigation is unlikely to end with the removal of the president.

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