Category Archives: Economy

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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Beijing’s Devaluation Dilemma

 

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THE CLOCK IS ticking down on the inauguration of US President-elect Donald Trump and thus on Beijing’s decision about if and how to devalue the renminbi. China is caught between an exodus of capital and whatever hawkish policies against it that a Trump administration could bring.

The renminbi fell 7% against the US dollar in 2016, in its biggest fall since 1994. Most of the fall occurred in the fourth quarter as the US Federal Reserve started to raise interest rates.

The case for a one-off step devaluation is that it would, assuming it was large enough, staunch the outflows, and end the need to run down the foreign-exchange reserves to defend the currency. The case against is that Chinese companies with dollar-denominated debt could be put in peril, importers would face a squeeze on margins and Trump’s strident accusations of China being a currency manipulator to support its exporters by undervaluing the renminbi would gain more credence.

Also, a Chinese devaluation could set off a round of competitive devaluations by emerging economies that would rock the world economy. There is ‘previous’ in this regard. Beijing’s unexpected devaluation in August 2015 caused global shockwaves.

At the same time, China’s foreign exchange reserves, being used, regardless of Trump’s claims, to prop up the currency through market intervention, are being eroded. While comfortably large at more than $3 trillion, even they cannot be run down indefinitely. The People’s Bank of China has already used $1 trillion of the reserves to defend the currency, taking them in December to their lowest level in six years.

And what probably matters more is investor sentiment. To that end the central bank earlier this month orchestrated liquidity squeeze in the offshore market in Hong Kong, to make it more expensive to bet against the renminbi, a signal intended equally to be read in the onshore market.

As the devaluation debate rages among policymakers, Beijing has been putting administrative measures in place to reduce the outflows. A stop has been put to the dodge of using investment-linked insurance policies in Hong Kong both to move savings overseas and switch into dollars. The level at which banks are now required to report all yuan-denominated cash transactions has been lowered to 50,000 yuan from 200,000 yuan.

The individual annual quota of $50,000 in foreign currency is unchanged, but citizens are being asked for more detailed information about why they need the cash;  tourism, business travel and medical care and education overseas is looked on favourable, but not purchases of overseas property and financial assets.

Similarly, a closer eye is being kept on Chinese firms foreign direct investment, especially M&A involving real estate, hotels and cinemas. Bitcoin exchanges, which account for 95% of global trading in the crypto-currency, are being leant on to stop a backdoor way to cash out of the yuan. There is even speculation about a crackdown on the excessive transfer fees Chinese football clubs are paying to bring in foreign stars.

In this environment, state-owned enterprises are likely to be leant on to repatriate foreign currency earnings held offshore while foreign firms will find it harder to repatriate their profits.

All of this flies in the face of policies to internationalise the currency that have been persued for some time, and whose continuance was implicit in the IMF’s adding of the renminbi to its basket for Special Drawing Rights last October.

The other conventional prop for a currency is higher domestic interest rates. However, with more than 1 trillion yuan of corporate bonds due to mature every month from now until the third quarter of this year, higher rates would impose a massive refinancing burden on companies.

Also, it is far from clear how much strain higher rates would put on the shadow banking system and what the spillover would be to the rest of the financial system, but the sense is that it is a significant risk.

That leaves devaluation — gradually or in a one-step change — as the most likely option.

In a sense, that is inevitable. Dollar strength globally is probably a bigger factor than renminbi weakness. Last month, however, that did not prevent Trump tweeting, “Did China ask us if it was OK to devalue their currency?” Nor is it likely to do so again.

Financial policymaking is difficult at the best of times, never more so than at a time of unpredictability — and with a clock ticking.

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World Bank Holds Its Growth Outlook For China Unchanged

THE WORLD BANK has left its growth forecasts for China to 2019 unchanged from its projections published last June. In the latest edition of its Global Economic Prospects, the Bank reiterates its view that growth this year will slow to 6.5% from 2016’s 6.7%, and then slow further to 6.3% in both next year and 2019.

The Bank takes note, however, of “resurfacing concerns about buoyant property markets, as growth slows gradually toward more sustainable levels, with a rebalancing from manufacturing to services”.

There is little unexpected in the Bank’s sketch of the economy. Growth has been concentrated primarily in services, while industrial production has stabilized at moderate levels. Strong consumption growth highlights the internal rebalancing on the demand side. Investment growth has continued to moderate from its post-crisis peak, concentrated in the private sector; investment by the non-private sector accelerated in 2016.  Fiscal and credit-based stimulus to growth in 2016 focused on infrastructure investment and household credit.

china-economy-chartCredit growth remains well above the pace of nominal GDP growth, with loans to households accounting for an increasing share of credit extension in 2016 on the back of a continued real estate boom, especially in first-tier cities. The ratio of household debt to GDP has surpassed 40%, up almost 10 percentage points over the past three years. Meanwhile, the ratio of non-financial corporate sector debt to GDP reached 170% in 2016.

Producer price deflation came to halt as input prices stabilized. If the cycle has swung back to reflation, as an uptick in global commodity prices as well as recent producer price index numbers might indicate, that would be a significant turning point.

Capital outflows remained sizable last year and continued to put downward pressure on the currency. During 2016, the renminbi depreciated by about 5% in nominal trade-weighted terms (and some 7% against the US dollar) albeit broadly in line with fundamentals.

The renminbi was added to the basket of currencies that make up the International Monetary Fund’s Special Drawing Right in October last.

Soft external demand, heightened uncertainty about global trade prospects and slower private investment are the key risks to the growth outlook for this year. Macroeconomic policy is likely to remain supportive. Meanwhile,  rebalancing from industry to services and from investment to consumption is expected to moderate.

Progress in reducing financial excesses will likely be similarly modest, barring deep structural reforms to state-owned enterprises and corporate restructuring  — both highly unlikely in a year that will see a party plenum that will start to line up the next generation of top political leadership. No sharp policy changes will be implemented which would raise disruption risk, even though the longer it takes to tackle deleveraging the higher the eventual cost will be.

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Industrial Policy’s Global Return

INDUSTRIAL POLICY HAS long been a strong pillar of China’s economic agenda but a pariah in the Anglo-Saxon economies of the West.

It made a return there last August when the UK’s new Prime Minister Theresa May outlined her vision of a post-Brexit state-boosted industrial renaissance some three decades after the UK’s previous female prime minister, Margaret Thatcher, had killed it off.

Now, in the United States, President-elect Donald Trump is picking up the torch with the creation of a White House National Trade Council to facilitate industrial policy. Peter Navarro, a University of California economist who is a sceptic of trade with China, is its proposed head.

This suggests that a more populist approach to trade and manufacturing is in the offing from the Trump administration. US trade policy will more likely be used to promote domestic production and job creation, particularly in infrastructure and defence, two areas where ‘Buy American, Hire American” is easiest to implement.

That would represent a significant change from international trade as a foreign policy tool that it was under the Obama, Bush and Clinton administrations.

It remains to be seen what this means in practice, and more importantly, where the new council fits into a Washington power structure that has to accommodate on economic matters the National Economic Council, the National Security Council, the Treasury, the U.S. trade representative and the commerce department.

Beijing, already sideswiped by Trump’s election win, will take its time to pick that apart.  Trump’s proposed commerce secretary, Wilbur Ross, the soon to be octogenarian investor who made his billions from corporate restructuring of distressed companies, is this Bystander’s pick to emerge as the key figure among that group. But Navarro’s appointment will not offer Beijing much cheer.

Navarro is also an advocate of the theory, controversial among economists, that trade deficits are a drag on growth. The United States ran a $366 billion merchandise trade deficit with China last year.

This Bystander will be watching carefully for signs of the Trump administration seeking to implement a ‘border tax’. This is taxation regime within corporate tax that Navarro and Ross have argued is needed to offset what they say is the hurt other countries’ domestic tax systems impose on US exports, say through the imposition of value-added-taxes that have no equivalent in the United States.

In short, they argued that a 20% border tax could eliminate the overall US trade deficit (if not all of the one with China). Imports would become 20% more expensive to cover the new corporate tax liability while exports, which would be exempt, would be roughly 12% cheaper because of the tax savings exporters would get.

The net effect of what in effect would be an across the board import tariff of 20% and an export subsidy of 12% would be equivalent to a 15% change in the value of the dollar.

Given that the United States was a $482 billion export market for China last year, that would give a very different hue to the China-US trade relationship. Not surprisingly, talk of a coming China-US trade war is in the air in both countries.

That may be of less import to China than once might have been the case now that it is rebalancing its economy away from cheap-export-led growth and towards domestic consumption, and that trade in services is becoming as important as trade in goods.

Nonetheless, this is probably not a moment to be sanguine about the prospects and the negative impact on China’s growth of a border tax could be material, and felt far wider than in China alone.

However, the new battle lines between Beijing and Washington may be drawn up over national champions as both countries seek to dominate the new industries that will shape the coming global economy. And that will come down to which nation will be better at picking winners — the perennial Achilles Heel of industrial policy.

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Stabilised Growth Lets China’s Focus Switch To Deleveraging

GOVERNMENT STIMULUS KEPT GDP expanding at 6.7% for the first three quarters, as close to bang in the middle of the official target range of 6.5%-7% as makes no difference. The economy has stabilised and looks to be back on its glide path of steady but slowing growth. However, the cost has been a deceleration of the ‘rebalancing’ of the economy towards consumption-driven growth and an acceleration in the accumulation of debt, particularly corporate debt, and particularly the debt of state-owned enterprises with excess capacity and real estate.

It was state government infrastructure spending, not private investment that kept growth going in the third quarter. An uptick in the property market helped, too, though caution is advised here given there was a 34% surge in sales but a 19.4% fall in new construction starts in September year-on-year as central and provincial governments introduced measures to cool off the property market).

Overall, state fixed-asset investment grew 21.1% in the first nine months whereas private investment was up 2.5%. However, the slowing growth in private investment seems to have bottomed out in the middle of the year while state investment growth similarly appears to have topped out in the first half.

That state investment spending has been on tick. The IMF’s Financial Stability Report released earlier this month highlighted the rising gap between credit growth and GDP growth. Total debt is about 250% of GDP, with corporate debt equivalent to more than 100% of GDP.

It is not so much the size of the debt-to-GDP ratio that is a concern; the United States has a similar ratio, for example, and the eurozone’s is a bit higher at 270%. It is the pace at which China’s is growing that alarms. At the end of 2007, the year before the stimulus to counteract the global financial crisis was launched, the figure was only 147%.

History suggests that any economy that has experienced such a rapid pace of debt growth will be confronted by either a financial crisis (e.g., the United States) or a prolonged growth slowdown (e.g., Japan). It is just a massive challenge for an economy to deploy such volumes of capital productively over a short time. Either the projects available offer diminishing investment returns and more and more loans to fund them go bad; there are only so many bridges to nowhere that can be built. Or credit starts to dry up.

The interconnectedness between the banks and the government due to the centrality of the state-owned sector in the economy makes a crisis unlikely. The government is effectively creditor and debtor. Also, domestic savings, not flighty foreign capital funds the debt. There is plenty of liquidity in the financial system, the People’s Bank of China will readily supply more if needed, and capital controls are in place to check capital outflows should they start to happen on a significant scale.

That is not to say the risk is totally absent. The proliferation of shadow banking products, particularly those offered by the country’s small banks, remains a significant vulnerability that could test the resilience of the country’s capital buffers.

Nonetheless, Beijing’s challenge in managing down debt levels is to avoid the second consequence, prolonged slow growth, and to do it with one hand tied behind its back having set itself in 2010, the target of doubling GDP and per capita income by 2020.

Of late, supporting short-term growth has been given priority over deleveraging to ward off long-term financial risk. Now, that growth looks to have stabilised (and slowing GDP growth to below 8% has not brought the apocalypse of social unrest predicted in the double-digit growth days), the priorities are changing.

The IMF has long expressed concern at China’s debt levels and the perils that persist in the shadow banking system. It recommends corporate deleveraging and opening up of the state-dominated service sectors to private firms, along with a stronger governance regime and hard budget constraints on state-owned enterprises within the broader context of moving to a more market-based financial system.

New guidelines from the State Council allowing creditors to exchange debt for an ownership stake in a debtor company are likely only a first step in that direction.

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The Renminbi Ups Its Status

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THE INTERNATIONAL MONETARY Fund added the renminbi to its basket of Special Drawing Rights (SDR) currencies at the start of this month, thus officially marking it as a member of the elite club of global reserve currencies. It is a membership of which China has long been desirous.

The IMF had decided last November that China could join at the next scheduled SDR review, and that it would constitute 11% of the basket. That gives it the third largest share, behind the dollar and the euro but ahead of the other member currencies, the yen and sterling.

Weightings are meant to reflect the use of a currency in trade and the financial system so China may have been treated generously in this regard. It share of global payments, for example, peaked at 2.8% last year and is below 2% now.

Joining the SDR basket is, at this point at least, as much symbolic as anything, an acknowledgement of the global weight of China’s economy, and encouragement to push ahead with the financial reforms that would make the renminbi the freely usable and widely adopted currency that IMF reserve currencies are meant to be.

That, in turn, would promote more foreign interest in yuan-denominated assets, particularly bonds. Central banks and sovereign wealth funds will, however, build up their renminbi-denominated holdings only gradually.

Looking back in a decades time, though, the change may look more momentous, both if China’s financial markets become deeper and more liquid or it turns out that the renminbi was just the first of several emerging market currencies (India’ rupee is another candidate) to find a place in the SDR basket.

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