Category Archives: Economy

Politics, Not Debt Will Drive The Deleveraging Of China’s SOEs

MOODY’S CREDIT DOWNGRADE of China caught the attention of the public prints, ever ready, in some quarters at least, to see the prophesied hard landing just around the corner, with the economy crumpling under the weight of an oncoming rush of bad debt. S&P did much the same as Moody’s back in March with much less general notice. In its commentary, Moody’s falls over itself to emphasise the long-term nature of the risk.

As this Bystander has argued before, while China’s debt-to-GDP ratio is large, and has grown in recent years, it remains manageable by Beijing, even in the event of a crisis, and the risk of external contagion is small.

That is not to say it is not of concern to policymakers. It is. It is concentrated in state-owned enterprises (SOEs) and local authorities. SOE debt, at 115% of GDP is concerning. (In Japan and South Korea state-owned corporate debt is about 30% of GDP). And the finance ministry has noted that some local authorities, caught between paying for shutting down loss-making state industries or subsidising them to keep them going, and no longer able to rely on land sales to square their books, are struggling to cover operating expenses.

All this is also a sign, widely commented on by the likes of the IMF, World Bank and the OECD, that the old-school means of state-led infrastructure investment to keep growth going are persisting to the detriment of ‘rebalancing’.  Those two points come together politically.

The political event of the year is, self-evidently, the Party plenum to be held later this year. This is no ordinary plenum, as it is the scene-setter for the next generation of leadership. President Xi Jinping’s legacy is at stake.

Vested interests lying in the way of economic reform have not been fully removed by the anti-corruption campaign. Many of those same interests would also end up on the wrong side of any aggressive debt resolution, given both the individual companies that would be involved and the structural reforms necessary to governance and financial markets.

So, for now, authorities are biding their time over the debt question. The economy has stabilised sufficiently to buy them a few more months of inaction; candidate Trump’s threatened trade war has been headed off; the razzmatazz around One Belt, One Road sustains hopes of new export markets for excess capacity.

Once Xi has consolidated his political control at the plenum, then the debt busters will start to move in.

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Even A Small Belt And Road Would Be Huge

Chinese President Xi Jinping delivers a keynote speech at the Belt and Road Forum in Beijing, May 14, 2017.

ONE BELT, ONE ROAD is ambitious. A network of roads, railways, ports, pipelines and other infrastructure that will crisscross China and Central Asia connecting to Europe and Africa via land routes (the Belt) and shipping lanes (the maritime Road).

It already covers two-thirds of the world’s population, one-third of global GDP and about a quarter of the world’s trade in goods and service.  China, President Xi Jinping announced at this weekend’s Belt and Road forum in Beijing (seen above), proposes to throw $124 billion at developing his vision of the next great engine of global trade.

Those monies would be a downpayment on what is estimated to be $900 billion of related investment, financed by a variety of Chinese or China-backed banks, funds and investing and development institutions. One Belt, One Road will, depending on your point of view, be 21st-century merchant hegemony writ large or the world’s largest platform for regional collaboration.

Leaders from 29 countries, the heads of the International Monetary Fund, World Bank, the UN, and a host of other dignitaries attended the forum this weekend, including most notably Russian President Vladimir Putin (absentees include the leaders of the United States, Japan and India). All the attendees, no doubt, will have had their private fears and hopes about the scale of this project to redraw over many decades the geoeconomic, and likely, the geopolitical map of Eurasia.

Whether China will hold the course, especially under Xi Jinping’s successors, is one question about the project. There are also legitimate concerns that some investment gets misallocated and ends up on being spent on ‘highways to nowhere’ and other projects that never should be built in the first place. Moreover, private and non-Chinese investment will be needed as well (and be a bellwether of global acceptance of the idea).

However, such is the scale of One Belt, One Road that even if only a fraction of it materialises, it will make Eurasia look a very different place.

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China’s First-Quarter GDP Growth Highlights Rebalancing Shortfalls

MORE UNRUFFLED WATERS for the Chinese economy–at least on the surface. First-quarter GDP growth, as reported by the National Bureau of Statistics, came in at 6.9% year-on-year.

That is its fastest pace in six quarters and the first back-to-back quarterly increase in GDP in seven years. The first-quarter number is also well in line with the 6.5% official annual growth target set last a month.

However, a closer look at the components of growth suggests that deeper currents swirl dangerously, and particularly that the old-school model of state investment-led growth still holds sway. Fixed asset investment in the first quarter, up 9.2%, was an acceleration from 2016’s 8.1% growth rate. Infrastructure investment rose by 23.5% while real estate development was up 9.1%. Industrial production also rose.

Worryingly for the rebalancing of the economy towards greater domestic consumption, retail sales growth slowed to 10% in the first quarter from 2016’s 10.4% expansion.

US President Donald Trump’s backing off from threatening a trade war with China because he needs Beijing’s cooperation in dealing with North Korea has provided breathing room for China’s economy, which it appears to be exploiting with some gusto.

The stimulus that Beijing has given the economy has led the International Monetary Fund to raise its forecasts for China’s growth this year and next in its latest World Economic Outlook to 6.6% and 6.2% respectively. That is 0.1 and 0.2 percentage points higher than its January forecasts and 0.4 and 0.2 percentage points higher than its October 2016 forecasts.

The question remains, however: how sustainable can this pace of growth be long-term without rebalancing taking more substantial hold and the problem of excess leverage being tackled?

As the IMF puts it:

The medium-term outlook, however, continues to be clouded by increasing resource misallocation and growing vulnerabilities associated with the reliance on near-term policy easing and credit-financed investment.

At some point, as prime minister Li Keqiang again emphasised, Beijing will have to switch growth gears. That will mean unwinding its most recent stimulus–very carefully. But that is unlikely to start happening until after President Xi Jinping has consolidated his political control at the critical Party plenum later this year.

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The Sound Of Another Trump Flip-Flop

100 yuan notes

IT IS ALL going rather swimmingly for China with the United States right now. Following the happily smooth summit between President Xi Jinping and US President Donald Trump in Florida last week, the US president has said that China is not manipulating its currency.

During his election campaign last year, Trump had repeatedly accused Beijing of artificially driving down the value of the yuan to increase its export competitiveness, and had said he would label China as a currency manipulator on his first day in office.

His about-turn pre-empts the US Treasury’s forthcoming biannual report to Congress on the foreign-exchange policy of the United States’ principal trading partners: being designated a currency manipulator by the US Treasury legally triggers US Congressional sanctions against the offending country.

In the Obama-era, the Treasury had always found a way to avoid that, but the risk to China once Trump won the election last November was acute.

Trump now accepts that China has not been manipulating its currency for a while. His need to work with Beijing on dealing with North Korea — regardless of his previous comments that the United States would take unilateral action against Pyongyang if China failed to rein in its neighbour as Washington expected — appears to have helped clarify his vision.

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OECD Edges Up China Growth Forecasts

THE OECD HAS raised its forecast for China’s GDP growth this year by one-tenth of a percentage point from the 6.4% forecast it made last November. It has also raised its 2018 projection by one-fifth of a percentage point, to 6.3%. The 2017 forecast puts it squarely in line with the new official target of ‘about 6.5%’.

Its nutshell summary is:

Growth in China is expected to edge down further by 2018 as the economy manages a number of necessary transitions, including shifting towards consumption and services, adjustment in several heavy industries, working off excess housing supply and ensuring credit developments are sustainable. Demand is being supported by very expansionary fiscal policy, including via policy banks, which in turn is boosting private investment and trade. Producer price inflation has picked up strongly, but consumer price inflation remains low.

The OECD also notes that the rapid growth of private-sector credit and the relatively high level of indebtedness by historic norms is a key risk. Non-financial companies’ high debt levels provide particular vulnerability to a rapid rise in interest rates or unfavourable demand developments, it says. The report also advocates spending be directed at health and education and directed away from adding to financial risks.

The significant uncertainty about the future direction of trade policy globally is a key theme in the report, which makes the self-evident point that a roll-back of existing trade openness would be costly. Around one in seven jobs in China is linked to participation in global value chains.

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Li Lays Out China’s Economic Goals For The Year

CHINA HAS SET its growth target for this year at ‘around 6.5%’, prime minister Li Keqiang told the annual session of parliament. That is down from 2016’s goal of 6.5%-7% and the outcome of 6.7%.

The glide path to slower but more sustainable growth continues. However, it will be a more cautious approach this year ahead of an important party plenum later this year at which the scope of President Xi Jinping’s second term and eventually succession will be set.

China also faces a more uncertain external environment economy than any time since the 2008 global financial crisis, while the stimulus that staved off deflation last year has left the debt crisis still to be dealt with. While China is perfectly able to deal with that on a macro level, signs of local stress are increasingly apparent.  The finance ministry has again just warned of the ‘the hidden-debt risks of local governments’, especially in the rust belt in the Northeast.

Li’s signalled that the leadership considered 6.5% growth a floor, though if there is any suggestion of social or political instability (and especially instability within the political elites), that floor will, no doubt, be lowered.

Last year, 726,000 workers were shifted out of rust-belt industries; this year another 500,000 will follow, according to the labour minister. China created more than 13 million new jobs last year, according to the official figures, but a further half a million redundant iron and steel workers and coal miners is a lot to absorb, and especially in places where few new industries are flourishing.

Removing excess capacity from heavy industry has proved more difficult than planned as has killing off ‘zombie’ state-owned enterprises.

Rebalancing the economy has also progressed more slowly than Xi laid out when he assumed the leadership four years ago; one reason is that he has repeatedly turned to old-school stimulus whenever the economy looked to be slowing too rapidly.

The government will have work to do to reduce last year’s fiscal deficit of 3.8% of GDP to the wished-for 3.0% (which was also last year’s target).

Li set another ‘about’ target, of ‘about 12%’ for broadest measure of money supply (M2). While that is less than 2016’s target 13%, it is still above end-2016  money supply growth of 11.3%. More monetary policy tightening is likely, barring severe adverse external headwinds.

The military budget will again be restricted to a 7% increase (1.3% of GDP), even though US President Donald Trump has promised a 10% hike in the United States’ defence budget. The United States spends 3.3% of its GDP on defence.

Beijing’s holding fast after decades of double-digit growth will increase the already sizeable spending gap, $600-plus billion a year against $140 billion a year, though off-budget procurement could add a further $50 billion to China’s number and the modernisation of the PLA will continue.

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Trump’s Withdrawal From TPP Opens Opportunity For China

THE TRUMP ADMINISTRATION’S withdrawal from the Trans-Pacific Partnership (TPP) free trade agreement opens up space for China to assume leadership of the development of trade and investment within the region.

Its own Regional Comprehensive Economic Partnership (RCEP) goes from being a poor second choice to virtually the only game in town. It limitation is that it encompasses Northeast and Southeast Asia along with Australasia, but not the Americas, the carrot that the TPP offered.

However, without the participation of the United States, the TTP is left floundering, for all the talk from quarters such as Australia that something can be salvaged. That would take several years at the very least.

RCEP would be substantial, accounting for about one-third of global GDP and one-half of the world’s population. It would incorporate all the Asian countries that had signed up for TPP plus TTP waiverers, such as Indonesia, and excluded, such India (not forgetting China itself, of course).

RCEP is considerably less liberalising of trade than TTP, however. The scope for exemptions on awkward sticking points is also greater, which may make reaching an eventually agreement easier, though.

Critically different from the TPP, labour, environmental issues are excluded form the RCEP negotiations, as is the role of state-owned enterprises.

RCEP’s primary focus is the trade in manufactures, although trade in services and investments will be discussed as one at India’s insistence. India is competitive in trade in services though less so in manufacturing and especially light manufacturing. It does not want trade in manufactures to be given priority over trade in services and investment, where its companies are competitive.

Intellectual property rights are also a point of contention. Tokyo and Seoul want high levels of IP protection, particularly for their pharmaceutical sectors, and akin to those proposed by the TPP, whereas poorer countries in the region want access to cheap medicines.

Beijing, however, may have both a short and a long game to play. The high standards proposed under TPP for intellectual property protections and the liberalisation of trade in services may well eventually suit Beijing as it gets more success in rebalancing its economy as a more services-oriented and innovate one.

To that end, it may well be prepared to keep the TPP negotiations lingering on should they be of future use. In the meantime, though, Beijing will seize the initiative that Washington has let drop.

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