The target is the lowest acceptable threshold and less significant than many believe. To some extent it is largely academic because actual growth always beats the target, by an average of 2.8 pps each five year period since the Seventh Five-Year Plan (1986-90). The actual growth print is immaterial: policy choices will be determined by fluctuations in the variables most closely associated with actual living standards, like employment. Thus, comments by the National Bureau of Statistics (NBS) head, Ma Jiantang, which confirmed that the unemployment rate ticked higher from 4.1 percent during the tail-end of the year, are timely. Of course, sluggish export orders and the still-pressured property sector will manifest in the labor market, which is why the government has given itself a conservative target of keeping the registered urban unemployment below 4.7 percent this year.

We remain wedded to our 8 percent growth forecast for 2012, and data this week will confirm that H1:12 will be a weak spot. Indeed, data out of will confirm that momentum loss has continued for the ninth consecutive quarter. Industrial production growth for both January and February are to be released on March 9. The Chinese Lunar New Year will continue to distort reality: after January’s downward bias, February will have an upward bias. The average value-add of industry for the first two months of the year is expected to have fallen back to a three-year low of 12.4 percent (a level reached in November).

The state will stomach headline inflation of 4 percent this year, which is above our forecast of 3.5 percent anyway. The target may be unchanged from last year, but is considerably lower than last year’s actual inflation of 5.4 percent. Indeed, inflationary pressures will continue to dissipate in H1:12 as the impact of falling food and commodity prices is magnified by favorable base effects.

The seemingly easy-to-achieve target provides importantly policy leeway for balancing cyclical activity and structural reforms. A target of 3.5 percent would have been more bearish for markets because it would have meant tighter policies for the year. In contrast, relatively soft growth is releasing pressure on capacity already, meaning that headline inflation should come in below 4 percent.

The higher inflation target creates space for price reforms in resources. Resource prices are artificially depressed. It is believed that reforming resource prices creates a wholesale change to the incentive structure of the economy, increasing the opportunity cost of inefficiency and wastage. Last year, adjustments were iced because inflation was too high. This year, crude prices have already been increased. The 4 percent target creates additional scope for the prices for end-users of water, oil and gas to be increased.

Inflation data for February is expected to resume the downtrend started in August. We expect inflation to fall sharply, from 4.5 percent in January to 3.3 percent y/y in February (versus consensus of 3.5 percent). Thus, inflation is already 3 pps below July’s peak and core is below 2 percent. Prices at the factory gate are moving even lower, falling from 0.7 percent in January to 0.2 percent in February.

The balancing of slower economic growth and structurally higher inflation will be tricky this year. Wages will continue to rise at double-digits, minimum wages are rising, and improving and wide-reaching social support will increase purchasing power. Moreover, money supply has surged from 150 percent of GDP in 2007 to 180 percent in 2011, injecting plenty of cash in the system, inflating prices of assets, goods and so on.

As expected, China will “prevent a rebound in prices” by maintaining “prudent” monetary policy. The tone is slightly at odds with the PBoC’s goal: (a) for total aggregate lending of 13-14 trillion yuan (versus 12.8tr yuan in 2011), and (b) money supply growth target of 14 percent this year. Clearly, the expansion of money supply will outpace nominal GDP growth (growth of around 8 percent and an inflation rate of around 3.5 percent). It is clear that policy lending rates won’t rise this year.

In addition, the tone of the report does suggest that market expectations of 200 basis cuts in the RRR (reserve requirement ratio) are too bullish and any cuts will continue to be spaced over the course of a few months.

Beijing will widen the daily trading band for the domestic currency this year. The daily range will increase from 50 bps to around 80-100 bps, probably by mid-year, adding much-needed flexibility to the exchange rate. However, Wen’s statement also stressed the desire to keep the exchange rate stable at a “balanced” level.

The path has been laid for flexibility in bank lending decisions. Banks were given the go-ahead to roll over maturing debt (by up to four years) last month and the RRR was cut. Prior to this, the State Council encouraged banks to lend to SMEs in November. Now, even though the China Banking Regulatory Committee (CBRC) will keep a vigilant watch on bank lending and loan quality, application of loan-to-deposit ratios for lending to SMEs, agriculture, social housing and other priority sectors are being used in a counter-cyclical manner.