Tag Archives: rebalancing

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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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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IMF Bangs On A Familiar But Necessary Refrain

THE INTERNATIONAL MONETARY Fund has left its growth forecasts for China this year and next unchanged at 6.6% and 6.2%. However, in the newly published edition of its World Economic Outlook, the IMF notes that “China’s growth stability owes much to macroeconomic stimulus measures that slow needed adjustments in both its real economy and financial sector”.

Policy support and opened credit taps stabilised growth in the first half of the year close to the middle of authorities’ target range of 6½% –7% for the full year.

The Fund bangs on a familiar drum when it calls for more decisive action in tackling corporate debt and governance issues in China’s state-owned enterprises (SOEs). Lack of progress on these, it says, raises the risk of a disruptive adjustment from reliance on investment, industry and exports to greater dependence on consumption and services. Rebalancing could become ‘bumpier than expected at times,” the Fund warns. The current short-term stimulus on which China is relying and a still-rising credit-to-GDP ratio exacerbate that concern.

Credit dependency is increasing “at a dangerous pace, intermediated through an increasingly opaque and complex financial sector”. A combination of factors are at work here: “the pursuit of unsustainably high growth targets, efforts to prop up unviable state-owned enterprises to preserve employment and defer loss recognition, and opportunistic lending by financial intermediaries in the belief that all debt is implicitly guaranteed by the government”.

The IMF’s policy prescriptions are similarly familiar:
• address the corporate debt problem by separating viable from unviable state-owned enterprises, harden budget constraints and improve governance in the former while shutting down the latter and absorbing the related welfare costs through targeted funds;
• apportion losses among creditors and recapitalise banks as needed;
• allow credit expansion to slow and accept the associated slower GDP growth;
• strengthen the financial system by closely monitoring credit quality and funding stability, including in the nonbank sector; continue to make progress toward an effectively floating exchange rate regime; and
• further improve data quality and transparency in communications.

The medium-term outlook for China remains clouded by the high stock of corporate debt—a large fraction of which is considered at risk. And vulnerabilities continue to accumulate with the economy’s rising dependence on credit, which complicates the difficult task of rebalancing the economy across multiple fronts:

The medium-term forecast assumes that the economy will continue to rebalance from investment to consumption and from industry to services, on the back of reforms to strengthen the social safety net and deregulation of the service sector. However, non-financial debt is expected to continue rising at an unsustainable pace, which—together with a growing misallocation of resources—casts a shadow over the outlook.

Spillovers from China’s rebalancing and gradual slowdown via global trade and increasingly financial channels continue to concern the Fund. These have been significant, and China’s growing global role, the Fund says,  makes it all the more important for it to address its internal imbalances.

However, it also notes the other side of the coin:

The outlook for emerging market and developing economies will continue to be shaped to a significant extent by market perceptions of China’s prospects for successfully restructuring and rebalancing its economy.

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A Scorecard Of China’s Economic Rebalancing

A NEWLY PUBLISHED IMF Working Paper takes the measure of Beijing’s progress in rebalancing the economy away from investment and export-driven growth to high-value-add innovation-led industry and domestic consumption.

In summary, the paper says:

External rebalancing has advanced well, while progress on internal rebalancing has been mixed, with substantial progress on the supply side, moderate progress on the demand side, and limited progress on the credit side. Rebalancing on income equality and environment has also been mixed, with the energy intensity of growth falling and labor’s share of income rising, but income inequality and local air pollution remaining very high.

The author of the paper has also created a visual traffic-lights type scorecard, with data going back to 2010 and forecast out to 2021.
untitled-2

We have taken the liberty of taking a snapshot of where we are now based on 2015 or most recent available data (see Table 1, left).

The IMF has long been cheerily upbeat about the prospects for China’s economic development — no dramatic headlines generated by dire warnings of the rising risks of a banking crisis, as came from the Bank for International Settlements in its latest quarterly review published this week.

While the paper does acknowledge in this regard that the risk of “a disruptive adjustment” will increase significantly in the medium term, it also says that buffers such as foreign-exchange reserves are still large and able to help absorb potential financial shocks, although they will likely diminish over time, especially if reforms lag.

The paper also notes that demographic and structural changes will provide tailwinds to China’s rebalancing. It is certainly true that the rapid ageing China will experience over the next 15 years will turn the demographic dividend that has helped power growth for the past three decades into a demographic deficit.

The paper underlines that “successful rebalancing requires coordinated progress on various fronts. Going too fast on one area, while too slow on others, may derail the whole process.”

That is also not to say that significant policy efforts are not needed to get there.

Specific recommendations include:

  • continuing to move to an effectively floating exchange rate regime to prevent future foreign-exchange misalignments;
  • raising government health care spending to encourage a lowering of the savings rate (always a treat to see the austere IMF urging a communist country to increase state spending);
  • deregulating services to drive service sector productivity to offset the impact of labour being re-allocated away from the high-productivity industrial sector. This also comes with a warning of the dangers of deindustralising too early and too fast;
  • pushing ahead with the glacial pace of reform of state-owned enterprises to improve the efficiency of credit allocation.  Currently, 40% of industrial assets are managed by SOEs, with asset returns some 7 percentage points lower than their private counterparts, the paper notes; and
  • improving the redistributive role of fiscal policy through a more progressive tax structure, increased transfers and strengthened social safety net.

No surprises in that list. All the prescriptions are out of the IMF’s policy toolkit for China that the Fund has been using to cajole for reform.

 

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Stimulus Spending Steadies China’s GDP Slowdown

THE SECOND-QUARTER GDP growth figure came in at 6.7%, the same as for the first quarter. So growth for the first half was surprisingly steady and, surprise, surprise, bang in the middle of the government’s target range for the year of 6.5%-7.0%. Policy support through state-sector infrastructure spending has done the trick.

More of it will probably be needed in the second half. The economy expanded at 6.9% last year, so the slowdown is real if gradual.

However, it cannot slow below 6.5% if the 2021 centenary of the founding of the Communist Party is to be celebrated by hitting the goal of doubling GDP from its 2010 level and thus creating a ‘moderately prosperous society’.

That, in turn, will require more progress on ‘rebalancing’ the economy than has been made to date. At the same time, the infrastructure spending being used to juice growth risks a build-up of more debt with the accompanying concerns that more of it will go bad.

As IMF deputy managing director Mitsushiro Furusawa noted at a symposium on July 11:

A rising share of debt is held by Chinese companies that do not earn enough to cover their interest payments. The most recent IMF Global Financial Stability Report estimated that “debt-at-risk” had increased to 14 percent of listed Chinese companies’ debt, up from 4 percent in 2010.

Still within the bounds of manageability, but moving closer to them rather than away.

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IMF Nudges Up China Growth Forecast, Cajoles On Reform

THE INTERNATIONAL MONETARY Fund has nudged up its growth forecasts for China over the next couple of years. The latest update to its World Economic Outlook says the Fund expects growth to be 6.5% this year and 6.2% next, both 0.2 percentage points higher than its January forecast, which in turn had been unchanged from last October’s.

These are both lower growth rates than 2015’s 6.9%, however. The Fund identifies policy stimulus as the reason for its revision, but adds:

A further weakening is expected in the industrial sector, as excess capacity continues to unwind, especially in real estate and related upstream industries, as well as in manufacturing. Services sector growth should be robust as the economy continues to rebalance from investment to consumption. High income growth, a robust labor market, and structural reforms designed to support consumption are assumed to keep the rebalancing process on track over the forecast horizon.

The Fund forecasts inflation to remain low at about 1.8% in 2016, reflecting lower commodity prices, the real appreciation of the renminbi, and somewhat weaker domestic demand.

It also notes the challenges of rebalancing and says with some understatement that the transition “has been bumpy at times”.

Slowing growth has eroded corporate profitability, which in turn, hinders firms’ ability to service their debt obligations, raising banks’ levels of nonperforming loans:

The combination of corporate balance sheet weakness, a high level of nonperforming loans, and inefficiencies in bond and equity markets is posing risks to financial stability, complicating the authorities’ task of achieving a smooth rebalancing of the economy while reducing vulnerabilities from excess leverage.

It also says:

Limited progress on key reforms and increasing risks in the corporate and financial sectors have led to medium- term growth concerns, triggering turbulence in Chinese and global financial markets. Policy actions to dampen market volatility have, at times, been ineffective and poorly communicated.

The risk is that:

A sharper-than-forecast slowdown in China could have strong international spillovers through trade, commodity prices, and confidence, with attendant effects on global financial markets and currency valuations.

That would be felt in both emerging market and advanced economies. On the upside well-managed rebalancing would ultimately lift global growth and reduce tail risks.

The Fund says the international community should therefore support Beijing’s efforts “to transit to a more consumption–and service–oriented growth model while reducing the vulnerabilities from excess leverage bequeathed by the prior investment boom”.

To that end, strengthening the influence of market forces in the Chinese economy, including in the foreign exchange market, is a key objective.  However:

Further structural measures, such as social security reform, will be needed to ensure that consumption increasingly and durably takes up the baton from investment. Any further policy support to secure a gradual growth slowdown should take the form of on-budget fiscal stimulus that supports the rebalancing process. Broader reforms should give market mechanisms a more decisive role in the economy and eliminate distortions, with emphasis on state enterprise reforms, ending implicit guarantees, reforms to strengthen financial regulation and supervision, and increased reliance on interest rates as an instrument of monetary policy.

The Fund notes the progress in financial liberalization and in laying the foundations for stronger local-government finances, but says, again, that the reform for state-owned enterprises needs to be more ambitious, clearly laying out and accelerating a substantially greater role for the private sector and hard budget constraints.

Easier to say than politically to execute. Little progress is being made on dismantling the clientelist structure of state-owned enterprises, as a reading between the lines of what this state media report on the recent meeting of the Leading Group for State-Owned Enterprises Reform doesn’t say highlights.

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China’s Economy Is Slowing Not Melting Down

THIS BYSTANDER HAS two brief points to make about China’s newly announced annual GDP figure, which came in at 6.9% for 2015, down from the previous year’s 7.3%.

First, the economy is slowing down, not melting down. That is what fast-growing industrial economies do after their growth spurts. South Korea and Japan did the same within living memory.

Second, for all the doubts, China’s national GDP numbers are no better or worse than those of most other large economies. (The quality of provincial level data is much patchier.) The less an economy is manufacturing based, the fuzzier GDP becomes as a measure. Services account for more than half China’s economy now.

What matters more is the pace of rebalancing the economy. On that, there is more reason for concern than whether GDP is a percentage point or two higher or lower than reported.

Update: In its new update to its annual World Economic Outlook, the International Monetary Fund has confirmed its expectation that China’s economy will continue to slow over the next two years. It has left its GDP growth forecasts for 2016 and 2017 unchanged at 6.3% and 6.0% respectively, noting that:

Overall growth in China is evolving broadly as envisaged, but with a faster-than-expected slowdown in imports and exports, in part reflecting weaker investment [as the economy continues to rebalance] and manufacturing activity.

In contrast, the Fund expects a gradual pick-up in the global economy from 2015’s 3.1% growth to 3.4% this year and 3.6% next, though the two forecasts are both 0.2 percentage points down from those it made in October.

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