Category Archives: Economy

Rate Cuts Highlight Tricky Growth Balance China Has To Strike

Chart showing China's quarterly GDP growth year-on-year from Q1 2019 to Q4 2021

CHINA HAS CUT interest rates for the first time in two years as the property sector debt crisis and a resurgence of Covid-19 weigh on the economy.

Fourth-quarter GDP growth came in at 4.0% year-on-year, its slowest pace of growth in 18 months. Quarter-on-quarter growth was 1.6%, up from the third quarter’s 0.7% but still far from robust.

While both the y-o-y and q-o-q numbers slightly exceeded consensus expectations, they confirm the return to the trend slowdown in growth seen before the distortions of the pandemic.

Year-on-year growth slowed in each quarter last year, although the economy expanded by 8.1% for the full year as it bounced back from 2020’s initial outbreak of Covid-19. The official target for 2021 was ‘over 6%’.

Retail sales rose by only 1.7% in December, much less than forecast, as new Covid-19 outbreaks forced new lockdowns in several cities. Investment also slowed, although industrial output rose.

The interest rate cuts by the People’s Bank of China signals a more assertive monetary approach than the easing already seen in the third quarter with the lowering of banks’ reserve requirement ratios.

Today’s cut in the benchmark one-year loan prime rate by ten basis points to 2.85% and the rate on seven-day reverse repurchase agreements to 2.1% follows December’s five-basis-points cut in the one-year policy loans rate. The five-year loan prime rate, the benchmark rate for mortgages, was left unchanged, but a reduction in that sooner rather than later would not be a surprise.

The reverse repo rate cut is the more unexpected of the latest cuts. It reflects authorities intention to stabilise the economy well ahead of the Party congress later this year when President Xi Jinping will likely be anointed to a third term.

A managed slowing of growth to rebalance the economy is politically tolerable, providing it comes with no social disruption. However, a property sector collapse with widespread developer defaults and the financial and social risk that would bring would not be.

The debt overhang remains serious. Corporate debt was still 156.8% of GDP in the second quarter of 2021. That is down from 163.4% a year earlier but still high enough to complicate the way forward for policymakers aiming to stimulate growth while reducing the economy’s reliance on debt-fuelled infrastructure investment and export-oriented manufacturing.

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World Bank Trims China Growth Forecast, Frets About Real Estate

World Bank estimates and forecasts of China's economic growth

THE WORLD BANK has trimmed half a percentage point off its estimate for China’s GDP growth last year and three-tenths of a percentage point off its forecast for this year and remains concerned about the risk of a prolonged downturn in the property market.

In the latest edition of its Global Economic Prospects, the Bank estimates China’s economy grew by 8.0% last year, down from the 8.5% forecast in June 2021. It forecasts 5.1% for 2022, down 5.4%, reflecting the lingering effects of the pandemic and additional regulatory tightening. It is holding its 2023 forecast unchanged at 5.2%.

Its forecast for this year is in line with China’s slowing trend growth.

In its commentary, the Bank says that manufacturing activity has been solid despite supply disruptions and electricity shortages, and export growth has accelerated, even as Covid-induced lockdowns and curbs on the property and financial sectors have restrained consumer spending and residential investment.

For now, macroeconomic policy measures have forestalled a sharper economic slowdown and mitigated financial stress. The People’s Bank of China has reduced reserve requirements, lowered its one-year loan prime rate and implemented significant short-term liquidity injections. The government has accelerated infrastructure investment, supported homeowners and creditworthy developers, and accelerated local government bond issuance.

However, looking ahead into this year, the Bank expects the effects of the pandemic and tighter sector-specific regulations to linger, with policy support only partly offsetting that. It also remains concerned about the possibility of a marked and prolonged downturn in the property sector—and its potential effects on house prices, consumer spending, and local government financing. It describes this as ‘a notable downside risk’ to its forecasts.

In China, financial stress could trigger a disorderly deleveraging of the property sector. Property developers such as China Evergrande have collectively accumulated financial liabilities approaching 30 percent of GDP. Moreover, corporate bonds issued by property developers accounting for a third of the sector’s liabilities have recently been trading at distressed prices. A turbulent deleveraging episode could cause a prolonged downturn in the real estate sector, with significant economy-wide spillovers through lower house prices, reduced household wealth, and plummeting local government revenues. The banking sector—local banks in particular—would be significantly impaired, raising borrowing costs for corporations and households.

Should that come about, the impact would be felt well beyond China. The financial stress would quickly reverberate across the region’s emerging markets and developing economies. The knock-on effect would be the risk of capital inflows suddenly drying up, triggering currency crises, especially in any country dependent on short-term inflows to finance its current account deficit.

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PBoC Indicates Careful and Selective Easing in 2022

Headquarters of the People's Bank of China, Beijing 2015. Photo Credit: bfishadow. Licenced under Creative Commons.

THE PEOPLE’S BANK OF CHINA (PBoC) on December 24 provided support for those who think that the central bank’s monetary policy will be more expansive early next year so that the slowing economy does not get ahead of its intended orderly decline.

The statement issued after its quarterly monetary policy committee meeting echoed the view of the Central Economic Work Conference earlier this month that:

The external environment is becoming more complex and severe and uncertain, and the domestic economic development is facing the triple pressure of demand contraction, supply shock and weak expectations.

In response, the PBoC foreshadowed its greater and pro-active support for the real economy through a more forward-looking and targeted monetary policy.

Small and micro businesses are one set highlighted for support. However, this came with the rider that the central bank will ‘strive to ensure that financial support for private enterprises is compatible with the contribution of private enterprises to economic and social development’ — a reminder that private enterprises must remember they are expected to contribute to common prosperity.

Two other stated objectives are to use monetary policy to realise the national goals of carbon peaking and carbon neutrality through developing green finance and safeguarding what the PBoC describes as ‘the legitimate rights and interests of housing consumers’. For those who track such things, the phrase ‘healthy development’ of the real-estate market preceded ‘virtuous circle’ in the statement.

GDP growth is likely to have slowed to 4-5% in the fourth quarter, although it will still come in above the 6% target for the entire year. Sub-6% growth is likely planned for in 2022, even if monetary (and fiscal) policy is carefully and selectively loosened, as the central bank indicates. Economic stability is the watchword for the coming year.

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The Chips Are Down For US Companies In China

THE APOLOGY TO China by US semiconductor manufacturer Intel for asking its suppliers not to use products and labour from Xinjiang due to human rights abuses against Uighurs is the latest example of a multinational company finding how uncomfortable it is to balance its reliance on Chinese suppliers and markets with the need to comply with US laws and sanctions and maintain its reputation in the West.

Its apology, posted on its Chinese social media accounts, that its commitment to avoid supply chains from Xinjiang was an expression of compliance with US law, rather than a statement of its position on the issue, was criticised for being insincere at best and duplicitous at worst in both China and the United States. The days when what is said in Chinese on Weibo of WeChat stays in China are long gone.

The nature of Intel’s product makes it less likely that it will suffer a consumer boycott in the way that Beijing punished fashion and sporting apparel companies H&M, Burberry, Adidas and Nike for similar perceived transgressions. Furthermore, like other countries, China is short of chips right now. However, the incident will reconfirm for policymakers their wisdom in expanding indigenous production to reduce reliance on US technology.

The greater risk to Intel is of retaliation against its operations in China, where it employs 10,000 people and generates a quarter of its revenue. Arbitrary administrative actions are the perpetual concern of foreign companies operating in China.

Late last month, Vice-Foreign Minister Xie Feng, whose portfolio is North America, met with representatives of US businesses operating in China, urging them to lobby against the Biden administration’s hardline stance against Beijing. None too subtly, he said that US companies that stayed silent could not expect to prosper in China. 

Speaking out in the way Intel did was not what he had in mind.

There is an emerging divide between US businesses that trade with China or source from it and those operating within the Chinese market. 

The former group seek to maintain as light a footprint in China as possible to minimise the ever-present risks against their operations and staff. Where possible, they operate arm’s length business relationships with local firms or licence their brands, products and services within the country.

The latter set has scant interest in the United States taking a harder line with China over commercial and technology issues, intermingling trade policy with national security, and the nascent decoupling of the two economies, most visible in capital markets and technology. 

Those companies, it should be said, show no indications of withdrawing from China. Yet they will have to become increasingly embedded in the ‘domestic circulation’ side of China’s ‘dual circulation’ development model, with all that that entails, and adjust their risk tolerance for damaging their reputation in international markets accordingly.

Given the changing attitudes in the United States and Europe towards China among lawmakers and corporate stakeholders like employees and customers, striking that balance may prove not only uncomfortable but impossible. 


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Why Supply Chains Are Not Moving Out Of China In One Chart

Chart showing the share of the global manufacturing base for selected countries

THE CHART ABOVE, from the Conference Board in the United States, crosses our desk and throws some light on why there is little evidence of supply chains moving out of China on any scale.

Simply put, the chart shows that there is no ready alternative that offers the scale and scope of China’s manufacturing base. In developing economies, such as those of Southeast Asia (for which ASEAN is a proxy in the chart), the capacity for multinationals to source inputs, labour and transport is a fraction of China’s. Even the United States and the EU combined barely match it, and in both those markets, labour costs are higher.

Moving production out of China will not happen quickly for other reasons, too. Supply chains are misnamed in that they are networks more than linear chains. They take years to put together and have extensive interdependencies. Companies will not willingly dismantle them quickly, even if they duplicate capacity elsewhere to improve resilience.

Further, dual circulation and the shift of China’s economy to being consumption-driven will mean that more of what is sold in China will be made in China. One small example: German car manufacturer BMW has just announced that it will start production of its X5 mid-size luxury SUV in Shenyang for sale in the Chinese market, rather than import the vehicles from its Spartanburg plant in the United States.

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Stability Concerns Will Drive China’s Economy in 2022

THE CENTRAL ECONOMIC WORK CONFERENCE that concluded this week does not appear to have brought anything to suggest other than the controlled slowdown of the economy will continue next year with an emphasis on authorities ensuring financial and social stability. 

That implies a continuing effort to ensure that the private sector aligns with the public interest as defined by the Party and that the efforts to wean the economy off its dependence on the property sector will continue in the drive for more consumption-based, sustainable and inclusive growth.

That, in turn, suggests that the regulatory crackdown will persist for some time, notably in non-SOE-dominated technology sectors. The reining-in of anti-competitive and big-data collection power will go on, and capital-market activity will also continue to be tightly if flexibly regulated. That, at least, is this Bystander’s interpretation of the cryptic mention in the Economic Work Conference of the promise of ‘traffic lights for capital’.

Those may all be measures to tackle the long-term headwinds of rebalancing and decoupling. More immediately, while the economy has rebounded from the worst of the pandemic-related disruption in 2020, it has slowed in the second half of this year due to global economic conditions and policy deleveraging, including cooling the property market.

Slowing exports to the United States and the EU in November indicate choppy waters in international trade that could get rougher if the Omicron variant causes a new wave of disruptive infections. 

Nor has the property crisis gone away. Beleaguered developer Evergrande has been declared in restricted default by the credit rating agency Fitch after the expiry of the grace period for a missed international bond payment. 

Authorities have the administrative and financial resources to prevent it from becoming a systemic risk, but the ‘restructuring’ of Evergrande still has to be managed in a way that ends the implicit guarantee of state bailouts for overextended property developers and their investors but does rescue the individuals and families who have bought their properties, built and unbuilt.

As the property sector accounts for 25-20% of GDP, this inevitably cannot be done without slowing growth. The People’s Bank of China has cut the reserve requirement ratio for banks by 50 basis points to an average of 8.4% to boost lending to generate some stimulus. The central bank offset this by repaying liquidity injections through its medium-term lending facility, indicating its concern about the risks of financial instability.

Signalling that stability is a macroeconomic priority suggests that policy in 2022 will be to continue the orderly management of deleveraging and the slowdown in GDP growth. Unemployment and the associated risk of social unrest, rather than GDP targets, are policymakers’ ultimate concerns. Those will determine the extent to which authorities will tolerate slower growth.

This year, the official GDP growth target is 6%, down from 6.0-6.5% in pre-pandemic 2019. The recommendation by the Chinese Academy of Social Sciences (CASS), the country’s leading research institution, that the government lower its 2022 target to 5% — to allow a ‘focus on promoting reforms and innovation and pushing for high-quality development’ — will be reflective of official intent.

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IMF Calls For China To Connect Climate And Rebalancing

Screenshot of IMP Country Page for China, accessed November 22, 2021

THE INTERNATIONAL MONETARY FUND’S most recent annual checkup on the health of China’s economy — more formerly the IMF staff’s 2021 Article IV Mission — carries few surprises.

The summary of the IMF team’s report says China’s recovery is well-advanced but unbalanced.

It also notes that the recovery is slowing because of the rapid withdrawal of policy support and the lagging recovery in consumption amid recurrent COVID-19 outbreaks, with more contagious variants posing challenges.

Recent power outages and a slowdown in real estate investment related to the ongoing policy effort to reduce leverage in the property sector are also weighing on growth. Regulatory tightening targeting technology sectors, while aimed at strengthening competition and data governance, has increased policy uncertainty.

In its October World Economic Outlook, the IMF forecast GDP growth of 8.0% for this year and 5.6% next.

At the same time, the downside risks are accumulating.

Short-term risks include continued pandemic uncertainty, consumption weakness, and elevated financial vulnerabilities. Declining productivity growth, increased decoupling pressures, and a shrinking workforce pose longer-term headwinds to growth.

The prescription will be familiar, too: reduce financial vulnerabilities to protect the recovery; and reaccelerate structural reforms to raise productivity and sustain high-quality long-term growth that is ‘balanced, inclusive and green’.

The Fund also wants to see supportive macroeconomic policies. It recommends that fiscal policy, which has been contractionary this year, should temporarily shift to a neutral stance and focus on strengthening social protection (a long-standing call on the IMF’s part) and promoting green investment over traditional infrastructure spending.

Given subdued core consumer price inflation and still significant economic slack, the Fund also wants monetary policy to be accommodative.

The passage on financial risks also has a familiar ring, even if those are now more urgent:

To safeguard stability, financial risks need to be addressed in a clear and coordinated fashion. Ongoing efforts to address high corporate leverage and phase out implicit guarantees for state-owned enterprises through regulatory strengthening should be accompanied by establishing market-based insolvency and resolution frameworks to safeguard financial stability and facilitate efficient credit reallocation and increase productivity. A comprehensive bank restructuring approach is needed to strengthen the banking system and improve its capacity to support the recovery.

Simultaneous implementation of additional key reforms—including a further opening up of domestic markets, reforming state-owned enterprises, and ensuring competitive neutrality with private firms while promoting green investment and strengthening social protection—will support the transition to high-quality growth.

The report also ties efforts on climate mitigation to economic rebalancing. It says that achieving the 2030 peak carbon and 2060 carbon neutrality goals will be most successful if China combines economic rebalancing towards a more consumption-based growth model with the use of carbon pricing tools, such as an improved national emissions trading scheme.

It also calls on Beijing to green the Belt and Road Initiative and aid the efforts to put low-income countries’ debt on a sustainable footing, including the timely implementation of the G20 Common Framework for debt treatment by all relevant Chinese entities. That is stronger wording on the debt point than in the 2020 Article IV Mission report, almost a rebuke by the standards of these reports.

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China’s Slowing Growth Stabilises, But Youth Joblessness Concerns

THE LATEST BATCH of monthly economic data, covering October, the first month of the fourth quarter, suggests the slowdown of China’s economy has stabilised, albeit at a slower pace than in the first half.

The National Bureau of Statistics says that retail sales grew by 4.9% year-on-year last month, up slightly from September’s 4.4% increase. Similarly, industrial output rose slightly, to 3.5% year-on-year from 3.1% the previous month. 

Fixed investment continues to slow, from 12.6% year-on-year for the first six months of 2021 to 6.1% year-on-year for the January-October period, with the property sector crisis still casting a long shadow. Real estate investment fell by 5.4% year-on-year in October. Housing starts were also down, as were home prices.

The problems in the property sector are long-term, and a sharper slowdown in the sector remains a risk. Authorities will be cautious about policy tightening while it is.

However, private investment overall grew by 8.5% year-on-year in January-October, more than twice state investment’s 4.1% pace. That is the mirror image of 2019 and 2020 when state investment sharply outgrew private investment.

More troubling for authorities is that while urban unemployment was down from 5.3% in October 2020, it was unchanged at 4.9% month-on-month, and the rate for 16 to 24-year-olds is nearly three times that. 

Creating sufficient skilled jobs for a well-educated population will be a challenge. Demographics are causing the workforce to shrink. However, the skills and qualifications of those now entering the labour market will be a mismatch for the jobs being done by those ageing out of it.

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Diesel Fuel Joins China’s Energy Shortages

DIESEL FUEL SHORTAGES are following China’s widespread electric power shortages as factories turn to diesel-powered generators to keep production going and wholesale prices higher than retail ones cause refineries to cut back production.

Petrol stations in many parts of China are reportedly rationing diesel, with lorry drivers reporting having to wait days in some cases to refuel, being limited to small quantities or being charged extra to fill up.

Lorries are the often overlooked underbelly of supply chains, so these latest fuel shortages and prices rises will put further pressure on already strained global supply chains.

Wholesale prices of petrol and diesel have risen by around one-fifth over the past month. They are now above government-set retail prices, leading to production cutbacks at refineries, as at power plants when coal and natural gas prices jumped.

Diesel output was down 4.4% in the first nine months of this year compared to the same period a year earlier, although it ticked up in September. Reserve inventories have been run down by about one-fifth. Meanwhile, retail prices have increased by 30% this year. Export supplies are being diverted to the domestic market.

The power and fuel shortages are pushing up producer prices — by a record 10.7% in September — although this has yet to work through to retail prices. Consumer price inflation rose just 0.7% in September.

In part, consumption is being depressed by lockdowns to contain a new wave of Covid-19 outbreaks that have spread to 11 provinces over the past ten days.

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China Lays Out Ambitious Vault To Net-Zero Carbon Economy

Chart showing share of non-fossil fuels in China's energy consumption: actual: 2010-2020, targets: 2025-2060

CHINA’S PATH TO ‘peak carbon’ by 2030 and becoming a net-zero carbon economy by 2060 is dubbed 1+N — one overarching blueprint and n number of implementing policies. On October 24, we got the ‘1’ in the form of a guidance document jointly released by the Party’s Central Committee and the State Council.

All future policy decisions on economic planning, macroeconomic adjustment and industrial policies will have to be compatible with the blueprint, which contains objectives and timelines for broad areas of the economy, including heavy industry, energy, transport, construction and finance.

The headline objective is raising non-fossil fuels share of energy consumption to at least 80% by 2060, a fivefold increase from 2020’s level, with a timeline for non-fossil fuels to hit a 20% share by 2025 and 25% by 2030. Both interim targets have been previously announced, but not the 2060 one.

Even before the current electricity shortages, coal accounted for approaching 60% of energy consumption, so scaling that back will be a dramatic change, and one being undertaken slowly.

Over the past five years, non-fossil fuels have been increasing their share of energy consumption by barely half a percentage point a year. That will need to be accelerated to triple that rate if the goal of creating a ‘green, low-carbon and circular economic system’ is to be met.

That is not only a question of increasing non-fossil fuel energy generation. It also means structural changes to industry and consumption to make the economy less energy-intensive. To have any hope of achieving its goals, Beijing will have to oversee the world’s largest reduction in carbon intensity.

As well as the coal, oil, and gas industries, chemical and petrochemical producers and steel makers can expect close attention from authorities regarding their energy efficiency.

The risks to economic growth inherent in a full-blown green transition are recognised. He Lifeng, head of the National Development and Reform Commission (NDRC), the top economic planning agency, says carbon reduction must be balanced with ensuring the security of industrial output and supply chains and, in what appears to be a nod to recent power outages, disruption to ‘people’s everyday lives’.

A leading group was established under the NDRC in May to guide and coordinate the transition. Yet, much of the implementation will depend on provincial and municipal authorities, and provinces will get some latitude over timing depending on the industrial structures.

However, local officials are on notice that their performance will be judged on their success in meeting their carbon reduction targets. Those who fall short can expect the same criticisms that came the way of officials who failed to meet economic growth targets when they were the benchmark. Officials will, no doubt, get as creative over emissions reductions accounting as they were with growth.

The guidance promises financial carrots as well as administrative sticks. Beijing is considering creating a national fund to promote the transition to a low carbon economy. That would likely support the development of carbon sinks, carbon capture and storage, and other carbon removal mechanisms.

An expansion of the national carbon trading market is all but inevitable. Supportive central banking (e.g., incorporating green credit into macroprudential assessment) and development of the green finance sector are also mentioned in the guidance.

So, too, is the encouragement of private investment in low-carbon industries. Banks and other financial institutions will be guided to provide long-term, low-cost funds for green and low-carbon projects. Policy banks will play a core role in underpinning long-term stable financing to support the green transition, which will not fail for lack of a plan.

This Bystander expects further details to emerge during the COP26 climate summit in Glasgow that starts at the end of this week.

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