Tag Archives: rebalancing

Powering Up Rebalancing

Bar chart of electric power consumption in China by sector, Jan-May, 2018, year-on-year % increase.

ELECTRIC POWER CONSUMPTION acts as a proxy for economic activity. These sectoral figures from the National Development and Reform Commission (NDRC) for the first five months of this year give a snapshot of where the growth is strongest, and points up how the economy is rebalancing.

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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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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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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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World Bank Ups Its Prospects For China’s Economy

THE WORLD BANK has become more bullish on China, at least for the near-term. In its newly published annual Global Economic Prospects, it has upped its estimate of GDP growth in 2017 to 6.8% (an 0.3 percentage point increase from its forecast a year ago and reiterated in June) and said it expects 6.4% growth this year (an 0.1 percentage point increase from its previous number).

China benefited, the Bank now says, from the recovery in world trade last year, fiscal stimulus and the rebalancing of the economy, which eased the drivers of the economy away from state-led investment. Inflation rose but was still within target and housing price increases moderated in response to policy measures.

The current account surplus continued to narrow, but the clampdown on capital outflows meant that exchange-rate pressures eased and foreign-exchange reserves recovered modestly.

On the flip side, non-financial sector debt continued to grow, reaching 260% of GDP, regardless of further monetary and regulatory tightening. Credit growth still outpaces nominal GDP growth.

The Bank says that financial sector vulnerabilities — particularly high corporate indebtedness in sectors with overcapacity and deteriorating profitability — are one of the key downside risks to growth.

Others include the possibility of protectionist policies in advanced economies (for which read the United States) and rising geopolitical tensions (for which read mainly North Korea).

The Bank also expects the economy to continue its measured deceleration, averaging 6.3% growth in 2019 and 2020, and less beyond that as adverse demographics kick in over the next decade.

A steeper-than-expected slowdown or debt- or geopolitical-driven financial stress would have impacts well beyond China’s borders.

The Bank’s view is that authorities have substantial ‘policy buffers’ to absorb financial shocks. Nonetheless, it, like others, calls for further structural reform to reallocate economic activity towards more productive sectors.

This would include financial and corporate sector reform as well as greater efforts to deleverage and improve the fiscal sustainability of provincial, municipal and local government.

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A Better Quality Economy

WHAT CAUGHT THIS Bystander’s eye from the annual Central Economic Work Conference, the key closed-door economic policy meeting of the year held in the PLA’s Jingxi Hotel in Beijing last week, was that economic policy priorities were set for the next three years rather than the usual one.

That will take policymaking to the midpoint of President Xi Jinping’s second term and the start of what should be the next cycle of leadership regeneration. It likely signals that there will be no alternative economic path than the one that leads to making good on Xi’s promise to build a “well-off society” by then.

The work conference was the first gathering of the Central Committee since the 19th party congress. It marked a start to translating Xi’s concepts of the next stage of China’s development being a transition from ‘rapid growth’ to ‘high-quality growth’ into plans and targets that each province and ministry will then have to turn into tasks and initiatives.

Xi has greatly tightened his grip over economic policy since taking power five years ago.The State Council, the mechanism through which the prime minister had formed economic policy, has become an implementation agency. The Central Leading Group of Financial and Economic Affairs, headed by Xi, is where the decisions that matter now get taken.

The outcome of the discussions at the work conference, which involved the 400 most important officials in the country, will not be disclosed until next March when they will be announced within the government’s work report to the annual parliamentary session as the economic targets for 2018.

All that is known at this point from state media is the already well-advertised transition from rapid to high-quality growth involving an economic model with “more focus on fairness, the environment and a joyful life”. The top three priorities for delivering that are alleviating poverty, pollution and financial risks.

Parsing that suggests that poverty relief will take precedence over maximising overall GDP growth, and financial stability over reform and liberalisation. Thus financial policy will focus on deleveraging through controlling credit growth rather than reducing existing corporate debt. Monetary policy will tighten in 2018; the external account will be kept stable, rather than opened up.

Systemic financial industry corruption will be tackled, particularly by cracking down on murky practice within shadow banking; more regulation in this area, particularly for asset management products, is likely next year. The introduction of a 3% value-added tax on some financial products will also provide a useful administrative tool for policymakers to bring shadow banking more in line.

It all adds up to a gamble on steering the real economy clear of financial risk through controlled growth and economic management. The gamble is probably most vulnerable to an external economic shock such as a deterioration in economic relations with the Trump administration in the United States.

The concern for Beijing is not the general macroeconomic one from US monetary policy ‘normalising’ but the danger that Washington’s China hawks get the upper hand in the administration and attempt to constrain China’s access to and trade in technology thereby crimping the innovation so necessary to rebalancing the economy.

What is less uncertain is that Beijing’s efforts to tackle environmental problems, and particularly air pollution, will be driven forward aggressively, regardless of the cost. That is for reasons of domestic stability, new-industry development and international leadership.

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