Category Archives: Economy

IMF, China And The Economic Elephant In The Room

Screenshot of IMF's Country Page for China

THERE IS SOMETHING other-worldly about the International Monetary Fund’s new report on its latest Article 4 Consultation with China: a rational analysis of structural economic reform amidst a maelstrom of tensions between Washington and Beijing.

The Fund’s report outlines the recent progress made by China in reducing financial sector fragilities and continuing to open up of the economy. It stresses the need for ‘staying the course on deleveraging and financial de-risking’ and for further progress in addressing distortions that encourage excessive household savings. It urges more reforms to enhance the social safety net and make the tax system more progressive.

It promotes greater exchange rate flexibility and deeper foreign-exchange markets to help the financial system prepare for increased capital flow volatility. It calls for increasing the role of the market and reducing the dominance of the public sector in many industries. It highlights the need to continue to move to a more price-based monetary policy framework and to address the misalignment of centre-local fiscal responsibilities.

All are laudable policy points, for which the Fund has long argued. The report summarises its prescriptions thus:

• Adjust macro policies and allow for a more flexible exchange rate. The announced policy measures are sufficient to stabilize growth in 2019 provided there are no further increases in tariffs. If trade tensions escalate further, additional stimulus, mainly fiscal, would be warranted.
• Improve external policies and frameworks by working constructively with trading partners to better address shortcomings and enable a trading system that can more readily adapt to economic changes in the international environment. The global economy would benefit from a more open, stable, and transparent, rules-based international trade system. China can also benefit from further opening up and other structural reforms that enhance competition.
• Continue strengthening the financial sector by fully implementing the announced regulatory reforms, strengthening bank capital, especially for smaller banks, and enhancing macroprudential tools to address vulnerabilities from rising household debt. Developing a clear resolution regime would facilitate the exit of weak banks. Removing the implicit guarantees and hardening the budget constraints for state-owned enterprises (SOEs) would improve credit allocation and limit SOEs’ advantage in accessing credit.
• Boost competition by opening up non-strategic sectors, particularly in services, to private and foreign enterprise, and unifying product markets across localities.
• Modernize policy frameworks by eventually moving to a single policy rate in the monetary policy framework, reducing the misalignment of centre-local fiscal responsibilities, and further improving transparency and statistics.

The elephant in the room is identified with masterful understatement by the first sentence of the accompanying press release: “The Chinese economy is facing external headwinds and an uncertain environment”.

The consultation and report predate the latest round of tariffs announced (and partially delayed) by the United States on Chinese exports and the Trump administration’s labelling of China as a ‘currency manipulator’, a designation that will drag the IMF unwillingly into that aspect of the trade war between Washington and Beijing.

It already has had Fund officials dancing gingerly around the question. In their view, China has not for some years been a predatory currency manipulator in the way US President Donald Trump now suggests to keep the yuan cheap to help Chinese exporters. If anything, of late, Beijing has been propping up the currency.

As this Bystander has previously noted, the conflict between the Trump administration and China goes beyond bilateral trade. It extends to structural issues related to the foreign investment regime, intellectual property protection, technology transfer, industrial policy, cybersecurity and the economic role of the Chinese state.

On many of these fronts, Fund staff would be happy for Washington to make headway, provided that it lead to more opening up of China’s economy in line with their long-standing policy recommendations. They would be less pleased, however, if any U.S.-China agreement resulted in managed trade. That, they believe, could negatively affect the multilateral trading system, and lead to an even more uncertain and challenging environment than we now have.

Even in the likely event that the two countries do not reach a comprehensive and durable agreement any time soon, persistent uncertainty is likely to weigh on both the near and longer-term economic outlook as China’s access to foreign markets and technology may be significantly reduced. That would mark a decoupling of the two largest economies that would be anything but ethereal.

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United States Brands China A Currency Manipulator, Escalates Trade Dispute

100 yuan notesIT IS A quarter of a century since the United States branded China as a currency manipulator. President Bill Clinton did so in 1994. Now President Donald Trump has followed suit.

The unexpected move marks an escalation in the bilateral trade dispute. As the Reuters news agency notes:

The announcement came hours after China let the yuan break through the key 7-per-dollar level for the first time in more than a decade, in a sign Beijing might be willing to tolerate more currency weakness as Washington threatens to impose more tariffs on Chinese goods from Sept. 1.

The decision will have more symbolic than practical impact. The sanction for currency manipulation is tariffs, which are already being applied. The US Treasury is now required to hold special talks with China, but broader talks over trade and technology are already in train.

If there is a new element, it is that the US Treasury will consult with the International Monetary Fund, dragging that institution into the bilateral dispute. Just three weeks ago, the Fund declared the yuan to be in line with China’s economic fundamentals and the US dollar to be overvalued by up to 12%. Awkward.

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China Edges Away From Deleveraging And More Towards Stimulus

 

Workers polish escalator parts in Zhejiang,China in 2016. Photo credit: ILO. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivs 3.0 IGO License.

THE DISMAL MONTHLY industrial output numbers for May, the weakest year-on-year growth in 17 years, point only too clearly to the binary choice for China’s policymakers: stimulate to keep the economy on track to grow at the 6% annual rate the official target demands, or deleverage to reduce systemic financial risk and continue to rebalance the economy in the cause of long-term sustainable growth.

They are doubling down on the first. Targeted stimulus, undertaken since last year, has come up short in the face of the global slowdown of growth and trade caused by the uncertainty generated by the United State’s foreign policy in general and trade policy in particular, with China directly in the Trump administration’s crosshairs when it comes to the latter.

Fiscal and now increasingly monetary loosening is already underway and local authorities’ are being given renewed licence to take on debt to enable real estate and infrastructure projects, just the sort of investment that ran up public sector debt in the first place, and which has been steadily reined in over the past four years.

There will be more loosening to come. Vice Premier Liu He told the Lujiazui Forum in Shanghai on Thursday that Beijing has plenty of policy tools and is capable of dealing with its various challenges. This was widely taken to be signalling imminent further cuts in either interest rates or the reserve ratio requirements for banks. Liu also put a positive spin on the international pressures on China, saying they would force the pace of rebalancing of the economy and opening of the financial sector.

This Bystander is not holding his breath. The longer deleveraging is put off in the cause of maintaining GDP growth above target, the greater the debt burden grows, and the closer the day of financial reckoning becomes.

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China’s First-Quarter Growth Lays Base For Hitting 2019’s Target

FIRST-QUARTER GROWTH came in slightly better than expected at 6.4% (consensus estimates were for 6.3%), and unchanged from the final quarter of 2018, confirming that the targeted stimulus applied since the second half of last year is taking effect.

The combination of fiscal and monetary measures helped boost industrial production in March by 5% year-on-year and retail sales by 8.7%. Fixed asset investment increased by 6.3%.

Beijing is targeting growth for the year at between 6% and 6.5%.

The challenges remain balancing growth with deleveraging and the prospect of a slowing global economy. The outcome of the trade talks with the United States is the wildcard.

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IMF Sees No Reasons For China’s Economy Not To Stop Slowing

A chart showing China's slowing GDP growth trajectory, 2010-2024. Source: IMF, Bystander Media

The IMF’s CHANGE in its forecasts for China’s growth this year and next go in opposite directions to those for the global economy as a whole.

In the new edition of its World Economic Outlook, The Fund projects 6.3% GDP growth this year and 6.1% in 2020. That is a one-tenth of a percentage point increase and reduction respectively on the Fund’s forecast in January, which in turn was unchanged from its forecast last October. However, for the world economy, it has cut its projections for this year but sees faster expansion in 2020.

The upgrade to the China forecast for this year is in large part technical. The Fund has dropped the assumption made in its previous forecast that the US tariff rate on $200-billion worth of trade would rise as threatened by the Trump administration to 25% from 10%.

China’s growth had started slowing in the second half of 2018 as a result of the measures to deleverage and rein in shadow banking, and the increase in trade tensions with the United States. At the same time, the consequent slower domestic investment was accompanied by softening consumption, particularly for cars, whose sales declined with the ending of incentive programs. The economy expanded by 6.8% in the first half of 2018, but by only 6.0% in the second.

For this year, the Fund expects economic conditions to improve as stimulus kicks in. Nonetheless, the external environment will be challenging: the advanced economies are slowing down; trade tensions with the United States are likely to persist regardless of any deal being struck in the near future, and there is likely to be a gradual tightening of financial conditions consistent with some further removal of monetary policy accommodation by the US Federal Reserve.

Even assuming no further increase in tariffs and a continuation of fiscal stimulus by Beijing, China’s economic growth is projected to slow this year and into next as the underlying forces that slowed growth in the second half of last year persist.

Longer term, the Fund sees a gradual slowing of the economy to 5.5% annual GDP growth by 2024. This is assuming the successful continuation of rebalancing towards a private-consumption and services-based economy and of the authorities’ actions to slow the accumulation of debt and mitigate its associated vulnerabilities.

This Bystander has less confidence in the second assumption than in the first. Cuts to personal income tax and value-added tax for small and medium enterprises should help stimulate domestic consumption. However, authorities also eased back on deleveraging and injected liquidity through
cuts in bank reserve requirements.

Any excessive stimulus to support near-term growth through a loosening of credit standards or a resurgence of shadow banking activity and off-budget infrastructure spending would heighten financial vulnerabilities — another reason that President Xi Jinping may be anxious to secure a deal with US President Donald Trump sooner rather than later.

If no deal is reached with the United States, that will cast a dark shadow over the medium-term outlook.

The Fund acknowledges that some centrally financed on-budget fiscal expansion in 2019 may be appropriate to avoid a sharp near-term growth slowdown that could derail the overarching reform agenda. However, it says this should avoid large-scale infrastructure stimulus and instead “emphasize targeted transfers to low-income households so as to lower poverty and inequality”.

It also lays out its familiar shopping lists of structural reforms:

Reducing leverage in the economy will require:
⁃ continued scaling back of widespread implicit guarantees on debt;
⁃ early recognition and disposal of distressed assets; and
⁃ fostering more market-based credit allocation that better aligns risk-adjusted returns with borrowing costs.
Continued rebalancing will require:
⁃ a more progressive tax code;
⁃ higher spending on health, education, and social transfers; and
⁃ reduced barriers to labour mobility.
Enhancing productivity growth will require:
⁃ reducing the footprint of state-owned enterprises; and
⁃ further lowering barriers to entry in certain sectors, such as telecommunications and banking.

As an endnote, the World Economic Outlook devotes a whole chapter to the link between bilateral trade tariffs and trade imbalances, and questions whether bilateral trade imbalances can (or should) be addressed using bilateral trade measures. Its conclusion is a rebuff to US President Donald Trump’s stated intention of using tariffs to cut the US trade deficit with China. It concludes that:

Targeting bilateral trade balances will likely only lead to trade diversion, with limited impact on country-level balances. The findings of this chapter help explain why, despite the tariff measures, the US trade deficit is the largest it has been since 2008. The chapter also establishes that the negative impact of tariffs on output is significantly higher today than in 1995 owing to the bigger role of global supply chains in world trade.

The paradox is that Trump’s tariffs will not achieve their stated aim of achieving balanced trade and have imposed a cost on US manufacturers and farmers, bu have got Beijing to the table to negotiate over structural reforms to its development model that it has never been prepared to talk about before.

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China’s New Foreign Investment Law Ready-Made For A Trade Deal

THE NEW INWARD foreign direct investment law, rushed forward and freshly rubber-stamped by the National People’s Congress, ticks all the boxes that Washington would want to see ticked.

But then it has been framed to do just that.

It overtly levels the playing field between foreign and Chinese companies in that it forbids forced technology transfer as a condition of foreign investment approval and makes it a criminal offence for officials to share foreign investors’ commercially sensitive information with Chinese firms (furnishing that information remains mandatory for local subsidiaries of international firms, however). Intellectual property protection is high on the list of US negotiators’ demands in the current round of US-China trade talks.

It also holds out an olive branch on another of their demands, greater market access, by adopting a ‘negative list’ system. Any sector not explicitly restricted will be open to foreign investors. However, there will still be 48 sectors that will remain off-limits, such as gene research, religious education and news media, or only conditionally accessible, such as oil and gas exploitation, nuclear power and airlines.

Regardless, both aspects can be packaged up to mutual advantage, a ‘win’ for the US side and a ‘concession’ by the Chinese one, though in truth they are neither.

When the new law comes into force on January 1, 2020, as with all Chinese legislation, it will provide a framework that will be open to interpretation and subject to enabling rules and regulations and the rigidity and frequency with which it is implemented.

Enforcement and redress via the courts is another matter. The judiciary is subordinate to the Party. Courts, particularly the new specialist business courts have due process, but also know their place. Every foreign firm investing and operating in China needs to appreciate that, and the difference between rule of law and rule by law. China has the latter.

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US-China Trade Dispute Moves From Technical To Political Phase

US PRESIDENT DONALD TRUMP has extended the March 1 deadline for raising tariffs on $200 billion of Chinese imports pending a summit meeting with President Xi Jinping in Florida probably in the second half of next month.

Trump tweeted that ‘substantial’ progress had been made in the high-level trade talks between the two countries.

State media have used the same description of the progress.

The negotiating teams have been working on the text of an agreement that will cover currency, cyber theft and forced technology transfers, services, agriculture, intellectual property and non-tariff barriers. These texts will provide the framework for what state media call ‘the next phase’ of discussions.

There is no official readout from either side of what that progress is but it is thought to have been greatest over the yuan-dollar rate, technology transfer, intellectual property protection and non-tariff barriers — all areas in which Beijing has already been moving in support of its long-term economic reforms to rebalance the economy. China will also be making some immediate large purchases of US goods and produce to cut its headline trade deficit with the United States.

The sticking points are likely to remain subsidies and other supports to state-owned companies, which go to the heart of China’s economic development model.

Until the finalised texts can be seen, it will be impossible to judge what ‘substantial progress’ means, what the pace and scope of it will be, what remains unsettled and what mechanisms will be put in place to monitor and enforce whatever is agreed.

The US team will make one more visit to China for further discussions on that. The fact that Xi is going to meet Trump in Florida in late March rather than on Hainan Island immediately after the Trump-Kim Jong-un summit is a sign of how much of a gap there is between the two sides still, and how little Beijing has conceded on that score.

There is also the little-mentioned question of what concessions will be expected of the United States.

For now, however, it will be all about appearances and how the two presidents control the ‘optics’ of an agreement, which both men need to appear to domestic constituencies as a ‘win-lose’ deal more than a ‘win-win’ one.

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