China's Monetary-Policy Surprise

In economic policy, as in most other areas, actions speak louder than words. By cutting its benchmark policy interest rates on November 21, the People's Bank of China (PBOC) has underscored the tactical focus of the government's stabilization policy, which aims to put a floor of around 7% on GDP growth.

Achieving this goal will be no small feat. China's economy is caught in the crossfire of structural and cyclicalheadwinds. Structural pressures havearisen from the shift to a new model of services- and consumer-led growth, and cyclical pressures stem froma tough global environment that hasput downward pressure on the old model ofexport and investment-led growth.

The cyclical challenges, in particular, are proving to be more vexing than anticipated. Though exports have declined considerably from their pre-crisis peak of 35% of GDP, they continue to account for about 24%, leaving China exposed to the global growth cycle – especially to markets in the developed world, where demand is exceptionally weak.
Indeed, 42% of Chinese exports go to Europe, the United States, and Japan – three economies that are flirting with secular stagnation. And Europe, China's largest export market, has struggled the most.

Given that development strategies typicallybegin to fail when economies reach middle-income status – a threshold that China is rapidly approaching – China cannot afford to allow mounting cyclical risks to undermine its structural transformation. Modern history shows that the easiest way for a developing country to become ensnared in the dreaded “middle-income trap” is to cling to its old model for too long.
The fact is that only structural transformation can lift a middle-income developing country to high-income developed status. Fortunately, China's leaders recognize this, and are committed to achieving it.

President Xi Jinping has been spearheading the effort to press ahead with reform and rebalancing. A year ago, at the Third Plenary Session of the 18th Central Committee of the Chinese Communist Party (CCP), Xi and his team created the country's most ambitious economic-reform agenda in 35 years. This, together with the 12th Five-Year Plan that wasenacted in 2011, highlights the authorities' commitment to bolstering the services sector and domestic consumption.

At the same time, China has been shifting responsibility for implementing reform from its antiquated planning apparatus (the National Development and Reform Commission) to a more effective market-based mechanism embedded in the CCP's structure (the Leading Small Group for Comprehensively Deepening Reforms). Add to that Xi's unprecedented anti-corruption campaign, and there is no turning back on China's road to rebalancing and structural change.

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