Category Archives: Economy

IMF Sees China’s Economy With Momentum To Face Headwinds

IN ITS LATEST World Economic Outlook, the International Monetary Fund has left its forecast for China’s growth this year and next unchanged from January’s 6.6% and 6.4% respectively.

Both numbers are one-tenth of a percentage point higher than the Fund’s forecast in October last year. They are also in line with the most recent forecasts from the World Bank and the OECD.

Faster than expected global growth and domestic policy support has sustained the economy in the form of resurgent net exports and healthy private consumption, giving it some momentum to propel it into the challenging headwinds of America First protectionism and still-risky domestic overleverage.

Thereafter, the IMF provides a familiar refrain:

Over the medium term, the economy is projected to continue rebalancing away from investment toward private consumption and from industry to services, but nonfinancial debt is expected to continue rising as a share of GDP, and the accumulation of vulnerabilities clouds the medium-term outlook.

And its obligatory silver lining:

Tighter regulation of nonbank intermediation in China, where nonfinancial corporate sector debt is still rising, is a welcome start of a needed policy response to contain the accumulation of vulnerabilities.

But it also highlights a missed opportunity:

Fiscal policy has played a vital part in shoring up short-term growth at the expense of eroding valuable policy space. Gradual consolidation, together with a shift of spending back onto the budget and away from off-budget channels, would help improve sustainability.

The Fund’s accompanying Global Financial Stability Report goes into greater depth about the elevated risks posed by what it says is the large-scale, tight and opaque linking of the banking system to the shadow banking sector (see diagram below) through its exposure to off-balance-sheet investment vehicles largely funded through the issuance of some 75 trillion yuan ($12 trillion) of investment products.

One-third of those by value are directly managed by the banks, who are seen as implicitly guaranteeing the products. A key challenge for authorities will be phasing out those implicit guarantees, which will require banks to improve their liquidity and capital buffers as there are large maturity mismatches between the products’ assets and liabilities.

Diagram of linkages within China's financial system. Credit: IMF Global Stability Report, April 2018

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Asian Development Bank Pushes Beijing On Tax Reform

Headquarters of the Asian Development Bank in Manila, Philippines, seen in 2016. Photo credit: ADB. Licenced under Creative Commons CC BY-NC 2.0

CHINA’S ECONOMY WILL grow by 6.6% this year and 6.4% next, according the Asian Development Bank’s newly published Outlook 2018. That is pretty much in line with the most recent revised OECD forecasts from mid-March.

The ADB sees strong consumer spending, rising exports and steady public spending underpinning current growth. It also joins the chorus calling for tax and other structural reforms to ensure that growth is both inclusive and sustainable as it resumes its measured glide path of slowing under the effects of excess-capacity reduction, the gradual resolution of the debt problem and the shift of growth drivers from capital accumulation to total factor productivity, to give a more technical description of the rebalancing of the economy.

In summary, the ADB says:

PRC growth accelerated on strong demand from home and abroad. The service sector grew by 8% on buoyant domestic demand, and net exports expanded as trade in intermediate manufactures rebounded. Assuming mildly tighter monetary and fiscal policies in the PRC, growth is expected to moderate from 6.9% in 2017 to 6.6% in 2018 and 6.4% in 2019. Further progress on reforms such as strengthening financial sector regulation and supervision, and addressing debt issues would lay a foundation for solid macroeconomic stability.

The ADB highlights the importance of services to rebalancing. In 2017, it notes, services were already the main driver of growth, expanding 8%, up from 7.7% the previous year, and contributing 4.0 percentage points to GDP growth. In contrast, industrial growth slowed to 6.1% last year from 2016’s 6.3%, and industry’s contribution fell to 2.5 percentage points.

The services sector also kept the labour market buoyant, creating 13.5 million new urban jobs last year (exceeding the official target of 11 million). But prices in the service sector are rising, meaning that inflation did not cool as much as it might otherwise. Consumer prices rose 1.6% in 2017, against 2% a year earlier. The ADB thinks inflation will pick up this year, to 2.4%, as consumer demand strengthens.

The ADB also notes in passing that services comprise barely 51% of GDP, low by international standards. As investment, in contrast, at almost 40%, is comparatively high, there is ample scope for further ‘rebalancing’.

The risks to the ADB’s forecast are pretty straightforward: a trade war with the United States, which could undercut exports and investment. It is not particularly worried about the tariffs the Trump administration imposed on steel and aluminium imports, seeing an unintended benign consequence of measures to tackle the corporate debt issue:

Prices for aluminum and iron ore (iron being the bulk of stainless steel) rose by 23% in 2017. This raised profits in the producers’ home economies more than enough to offset the impact of tariffs, had they been imposed a year earlier. Profits in heavy industry, including large steel producers in the PRC, rose by 21% in 2017 thanks to higher prices and government-imposed production quotas, allowing these industries to service their debt and reduce borrowing while trying to shed excess capacity. Thus, these producers should be able to manage lower demand expected from the US, given the small share of exports to the US directly affected.

However, it is the United States’ next round of tariffs on Chinese exports of intermediate inputs, especially for renewable energy, electricity generation and electrical and optical equipment, that is the immediate concern as they could undermine the business and consumer optimism. Absent Trump’s ‘massive trade deal’ with China, these will take effect in the next few months and would play directly into investment intentions, and especially those connected to US firms’ links to Asian value chains in manufacturing.

The double risk is that a strengthening dollar on the back of rising US interest rates could also spur greater capital outflows, irrespective of authorities’ discouragement.

However, the ADB believes, the government’s fiscal strength and political will enable the economy to weather any squalls. The question for this Bystander is how stormy the trade can weather get.

The particular area for structural reform tha is exercising the ADB is tax:

[The] ratio of tax revenue to GDP has stagnated at 17.5%, with heavy dependence on indirect taxes in the PRC atypical at its stage of development. The authorities there should broaden the tax base while ensuring that the revenue system is progressive.

The average tax revenue to GPP figure for OECD countries is 25%, and even in the ten emerging economies of the G20 countries, it is 21%. The combination of falling tax revenue and rising expenditure translates into rising budget deficits for Beijing, more public debt and thus contingent liabilities.

The ADB suggests that there is there is substantial potential to raise more revenue from personal income taxes, which are now paid by fewer than one in five wage earners. Personal exemptions are twice the annual average national wage, and the top rate (45%) kicks in at 35 times the annual average national wage. OECD averages are for personal exemptions of one quarter the average annual national wage and top marginal rates starting at four times that level.

This indicates some easy changes that could be made to broaden the income tax base and make it more progressive. (which are in train as was signalled at last month’s National Peoples Congress sessions). Structural tax reform is also central to tackling income inequality, a central concern of the Xi administration.

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China Readies A New Era In Financial Policymaking

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

THE GOVERNANCE REORGANISATION rubber-stamped by the recently concluded National People’s Congress has significantly changed the policy-making and regulatory landscape of the financial system.

As with other parts of the administration, it has consolidated agencies and strengthened the Party’s leading role over state administration.

The People’s Bank of China (PBOC) has emerged as the institutional lynchpin of the system with the banking and insurance industry regulators merged into the new China Banking and Insurance Regulatory Commission (CBIRC) and now reporting to the PBOC.

The central bank will be headed by Yi Gang, previously deputy to Zhou Xiaochuan, now 70 and who is retiring after 15 internationally respected years as governor. Yi nominally reports to the Standing Committee of the NPC but in effect to Liu He, long President Xi Jinping’s closest economic advisor and now elevated to vice-premier in charge of economic policy.

This all leaves China’s prime minister, nominally the country’s second-ranking official and customarily the one responsible for running the economy, pretty much out of the picture. That has been the de facto case for some time as Liu has been steering financial and economic policymaking from the leading group on the economy.

As vice premier, his remit will run to the financial sector, state-owned enterprise reform, industrial policy and relations with the United States. The remit underlines the twin challenges that China faces from a level of debt approaching 300% of GDP and in dealing with a United States that seems ready to start a trade war if that is what it thinks will let it get the upper hand in what the Trump administration sees as the United States existential struggle with China.

Liu’s academic credentials and worldliness are immaculate for a policymaker. However, his bureaucratic experience does not match. Yi’s promotion at the PBOC signals not only policy continuity at the central bank as it tackles deleveraging but the need for operational expertise, which Yi, a 21-year veteran of the central bank, brings.

Similarly, the appointment of Guo Shuqing as the Party boss in the central bank, and thus Yi’s senior in its political hierarchy, adds another experienced and tough-minded financial regulator to the mix — not to mention another ally of Xi’s.

Guo also heads the new CBIRC, previously having been chairman of the China Banking Regulatory Commission where he led the crackdown on shadow financing and helped clean up the interbank lending market. He has also been prominent in taming the more ambitious overseas acquisition ambitions of some Chinese companies and has experience as a stock market and foreign exchange regulator.

How the duopoly at the head of the PBOC will work in practice is illustrated by the fact that Guo also becomes deputy governor, with the ‘reform’ mandate, while Yi has been appointed deputy Party chief.

Zhou combined both the Party boss and governor’s role (although the foreign ministry has a similar split arrangement.)

China has no truck with Western notions of central bank independence as given to the US Federal Reserve, the Bank of England or the European Central Bank. The PBOC is subordinate to the government, which in the Xi era means evermore to the Party as he strengthens the Party’s leading role.

In that light, it will be Liu who will be setting the direction of, and Yi who will be running China’s financial and monetary policy with Guo ensuring regulatory and supervisory coordination on the one hand and political coordination on the other.

All three men are long-standing advocates of financial liberalisation. However, there are urgent short-term issues to resolve, notably the United States and debt, that will slow progress toward liberalisation. Cautious opening up of access to the financial system to foreign investors and more internationalisation of the yuan will continue, albeit not at the cost in either case of deregulation elevating financial risk.

One of the reasons for the consolidation of the supervisory agencies is to cut out as much as possible the regulatory fragmentation that has allowed the shadow banking system to take root. Financial stability is the political priority right now. The marching orders from the trio’s now all-powerful boss are to clean up the debt and rebalance the economy without crashing it — or having the United States crash it for them.

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OECD Raises China Growth Forecast And Risks To It

THE OECD HAS edged up its growth forecast for China this year to 6.7% from the 6.6% it projected in November but holds its 2019 forecast unchanged at 6.4%. The revised numbers are contained in the newly published interim Economic Outlook from the rich countries’ think tank.

Overall, the OECD sees a steady or improving expansion across most G20 economies thanks to the bounce back of trade and private investment, with fiscal stimulus in the United States and Germany providing a boost to short-term growth, while inflationary pressures are subdued. Specifically, on China it says

Growth surprised on the upside in China in 2017, helped by a strong rebound in exports, but is set to soften to just below 6½ per cent by 2019. Macroeconomic and regulatory policies are gradually becoming more restrictive, the working age population is now declining and credit conditions are less expansionary. Regulatory efforts are continuing to reduce financial risks, deal with overcapacity in some sectors and improve environmental quality. Fiscal policy is now broadly neutral, but additional measures could be implemented if output growth were to slow more sharply.

However, the risks to its general forecast all threaten particular vulnerabilities of the Chinese economy: tightening monetary policy in the advanced economies, high debt and asset valuations, and a potentially damaging escalation of trade tensions.

The importance of tackling high debt levels is illustrated in this chart.

Chart of G20 total debt, public and private non-financial sector, as % of GDP, 2001-2017. Source: OECD

The OECD calls on Beijing for policy initiatives to reduce the high level of corporate debt, in particular.

The OECD also makes a point of the importance of safeguarding the rules-based international trading system. China has repeatedly been saying the same thing, if somewhat self-servingly and with itself as the guarantor, since long before the Trump administration announced import tariffs on steel and aluminium. It is likely to echo the call again as the United States readies a Section 301 action on intellectual property rights and technology transfer practices aimed at what the US president has flatly called China’s theft of US technology.

Meanwhile, the Trump administration has reportedly told Beijing that it has to come up with a plan to reduce China’s $375 billion trade surplus with the United States by $100 billion within a year.

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Steady GDP Growth Target Reflects Measured Derisking

Chinese Premier Li Keqiang delivers his work report at the first session of the 13th National People's Congress in the Great Hall of the People in Beijing, March 5, 2018. Photo credit: Xinhua.

THE OFFICIAL GDP growth target for 2018 is ‘around 6.5%’, the same as last year, when the outcome was a forecast 6.9%, Prime Minister Li Keqiang (above) told the National Peoples Congress in his annual work report. However, the aspirational text from last year on the upside of the target has been dropped for this.

More significantly, the deficit target has been cut for the first time since 2012, to 2.6% of GDP from 3.0%, and monetary policy is to remain neutral, suggesting a tightening of the fiscal screw as authorities’ preferred way to de-risk the financial system.

If the 6.5% growth target is hit, China will be comfortably on course to achieve the goal set in 2010 of doubling per capita GDP by 2020 and thus making it a ‘moderately well-off society’. Growth needs to average only 6.3% between 2018 and 2020 for the target to be achieved.

Less certain is the extent to which quality of growth will replace quantity, as advertised at October’s quinquennial Party Congress. Li repeated the intention to reduce debt-fuelled investment, pollution, poverty and industrial overcapacity, in line with the Party line, but a 6.5% growth target would imply more economic stimulus or less fiscal drag than might otherwise be expected under the managed long-term slowdown and rebalancing of the economy.

That continues incrementally. He Lifeng, head of the National Development and Reform Commission, said on the sidelines of the NPC that consumption is likely to contribute around 60% to economic growth in 2018, up from 58.8% last year and barely 56% five years ago.

He also identified plate glass, cement and electrolytic aluminium as among the next round of target industries for capacity cuts.

The new GDP growth target also implies that the pace of structural financial reform will remain cautious, as it has been for some time. Deleveraging via cracking down on corporations, as happened to Anbang and more recently CEFC China Energy, will continue to be a way of removing excess financial risk from the system while serving the twin goal of aligning private sector foreign direct investment with the national interest.

Similarly, on the debt issue, Finance Minister Xiao Jie indicates that administrative action will be taken against irregularities in local government financing. Local governments account for 55% of the combined debt of central and local governments of  29.95 trillion yuan ($4.75 trillion) at the end of last year.

While some progress has been made on both reducing local government debt levels and structural reforms to local government financing, local governments remain overly dependent on land sales, with the concomitant risk of abuse.

However, a trade war, depending on its severity and duration, might make all that moot.

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Anbang Nationalisation Underlines China’s Financial Stability Priority

Logo of Anbang Insurance Group. Photo credit: Mighty Travels. Licenced under Creative Commons.

WU XIAOHUI, THE politically well-connected chairman of the giant insurance group Anbang (his wife is Deng Xiaoping’s grand-daughter), has been in detention by authorities since last June. Now he is to stand trial for economic crimes, code for fraud and embezzlement, and the company run by personnel from the China Insurance Regulatory Commission for a year or two, an extraordinary move. The state assuming control of a private-sector business, and particularly one of this size and prominence, is unusual.

Anbang has been on an aggressive international acquisitions drive, buying such foreign trophy investments as the Waldorf Astoria in New York and a string of other luxury US hotels. Chinese firms, with official encouragement, have ‘gone global’ in recent years, rapidly expanding their international mergers and acquisitions activity.

In 2016, China overtook Japan to become the world’s second-largest overseas investor. Non-financial outward direct investment that year exceeded $170 billion, a 44% increase from the previous year, according to the Ministry of Commerce. However, such activity entails tremendous financial risk from the leverage taken on, a risk exacerbated by Chinese firms’ lack of experience with the integration and management challenges that M&A brings, especial in deals that cross national and cultural borders.

Anbang appears to fall squarely in this camp. On some estimates (its finances are notoriously opaque), it has encumbered itself with debt to the point that it is fast approaching technical bankruptcy despite having more than $300 billion of assets.

That also makes it ‘too big to fail’. State administration will provide the funding to keep its core life and non-life insurance business operationally solvent. The insurance regulator says the company’s current operations remain stable but that its solvency is seriously endangered by its ‘illegal operations’ unspecified but which presumably include its investments in prestige prime US real estate.

Last August, authorities announced a list of sectors hat should be off-limits for Chinese firms as the foreign investment spree into things like European football clubs and Hollywood entertainment businesses was exacerbating debt concerns.

More broadly, in the drive for financial stability and to forestall any systemic financial shocks, President Xi Jinping has been asserting greater control over state enterprises and reining in sprawling private conglomerates, notably the ‘big four’ — Angbang plus Dalian Wanda, Fosun International and HNA Group — that have expanded rapidly via debt-fuelled foreign acquisitions.

That quartet that accounted for 20% of Chinese foreign acquisitions in 2016. Also, there has always been a nagging suspicion that, given the quartet’s political connections, some of this M&A acted as a conduit for senior officials to get their money out of the country.

All have been ‘urged’ to sell assets and pay down their debt while state banks were told to rein in their lending to them. In January, the chairman of the Banking Regulatory Commission, Guo Shuqing, warned that ‘massive, illegal financial groups’ posed a grave threat to financial reforms and the stability of the banking system and that China would address the issue ‘ in line with the law’.

Taking Anbang into state control may be the prelude to a series of moves against the layer of private conglomerates below the ‘big four’, a group of some 25-30 companies said to be in the regulators’ sights. Despite or perhaps because of his connections, Wu’s treatment, in particular, is intended to show that no tycoon is immune from being ‘deterred’ from risky borrowing and investment overseas, or from being reminded that private M&A strategies should be integrated with national investment priorities.

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China’s Economy: Normal Slowing Will Resume in 2018

THE ECONOMY STORMED along in the second half of last year, taking growth for the year to 6.9%, comfortably outstripping the official target of ‘around 6.5%’.

It was riding the coattails of the fiscal stimulus introduced in the first half of the year and also the pick-up in global trade, partly helped by the robust growth in the United States and some recovery in Europe, which boosted China’s exports. At 8.7% of China’s GDP growth, net export volumes made their largest contribution to growth since 2008.

Policymakers have been managing a slowdown from the giddy decades of double-digit growth. The overall lesson from last week’s figures is that economy is fitfully rebalancing and that there was some slowdown in credit growth as official efforts to cool the property market, deleverage and upgrade industrial capacity gained some traction.

That last year turned out to be the first acceleration since 2010 should prove to be an anomaly. Normal slowing will resume this year. And especially if policymakers push ahead with measures to control financial risks.

The most recent forecast from the World Bank, which recently upped its estimate of GDP growth in 2017 to 6.8% (a 0.3 percentage point increase from its forecast a year ago and reiterated in June) says it expects 6.4% growth this year (a 0.1 percentage point increase from its previous number).

Beijing has plenty of headroom in meeting its 2010 target of doubling aggregate and per capita growth by 2020. The economy needs to average no more than 6.3% growth to achieve that.

That headroom will also let Beijing tackle its most pressing economic-related problems: curbing escalating debt; cutting excess heavy industrial capacity; becoming environmentally cleaner; and dealing with the risk of unemployment as the economy is rebalanced towards domestic consumption and higher-value-added manufacturing.

Where the margins of safety are considerably thinner is if there is a trade war with the United States.

As we noted recently, US President Donald Trump is itching to impose tariffs on Chinese steel and aluminium imports into the United States. More recently Washington has said that an investigation into intellectual property transfers to China has been launched, with Trump warning that China is in for “a very big intellectual property fine”.

His self-restraint because he needs Beijing’s help with North Korea is wearing thin. Nor will it have been helped by the revelation that an ex-CIA officer arrested in New York this week may have been the mole responsible for passing information to Chinese intelligence that led to the dismantling and death of the CIA’s intelligence network in China between 2010 and 2012.

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