Tag Archives: rebalancing

IMF Again Warns China Off Growth For Growth’s Sake

THE IMF’S NEWLY published World Economic Outlook projects a 0.1 percentage point increase in GDP growth this year over last, to 6.8%. That is an upward revision of 0.1 percentage point to its July forecast, based on policy easing and stimulus to domestic demand earlier in the year.

However, the Fund sees the glide path of managed slowing growth resuming next year, with GDP growth forecast at 6.5% in 2018 (again up 0.1 percentage point from July’s forecast, and up 0.2 percentage points from its April forecast) and thereafter slowing further to 5.8% by 2022.

By that point, the IMF expects China to be growing more slowly than the emerging and developing Asia average, forecast at 6.3%. That would a phenomenon not seen since China started its double-digit growth spurt.

That, in its way, would be a mark of success for the rebalancing of the economy towards being more consumption-driven and less dependent for growth on infrastructure investment and exports. The IMF is projecting that China’s current account balance will have shrunk to $28.8 billion by 2022, against $196.4 billion last year, and almost one-tenth of the level it was a decade ago. As a percentage of GDP, the effect will be even more dramatic: a projected 0.2% in 2022 against 4.7% in 2009.

All neat projections, but realizing them is not without risk, most notably in managing debt:

Over the medium term, dealing with financial sector challenges will be essential. Minimizing the risk of a sharp slowdown in China will require the Chinese authorities to intensify their efforts to rein in the credit expansion.

The conundrum is that 6%-plus growth is necessary for China to have met its target of doubling real GDP between 2010 and 2020. To make sure it does, Beijing will be in no hurry to withdraw its stimulus.

However, as this Bystander and others have noted before, delay comes at the cost of further increases in debt, making the issue more difficult to resolve through the necessary measures of tighter supervision, reined-in expansion of credit and writes down of the underlying stock of bad assets.

This, in turn, would slow rebalancing and reduce the policy space available to respond in case of an abrupt shock to the system, internal or external.

Such shocks are not difficult to imagine, and are detailed by the Fund:

a funding shock in the short-term interbank market or the funding market for wealth-management products; the imposition of trade barriers by trading partners; or a return of capital outflow pressures because of a faster-than-expected normalisation of US interest rates.

The political dimension to this, unaddressed by the IMF, not surprisingly given its sensitivity, is whether President Xi Jinping will emerge from next week’s Party Congress in a sufficiently strong position to be able deemphasize near-term growth targets and implement more reforms that would enhance the sustainability of growth. Without doing so, he will be unable achieve his long-term goal of maintaining the Party’s monopoly grip on power while transforming China’s economy to its next phase of development.

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VAT And China’s Other Taxing Problems

CHINA STARTED TO replace its Business Tax with a value-added tax (VAT) in 2012 when a pilot scheme was launched in Shanghai. VAT has since been steadily expanded, both geographically and sectorally.

Earlier this month, following an executive meeting of the State Council, chaired by Prime Minister Li Keqiang, plans were announced for streamlining the administration of VAT and acknowledging that it has become a universal national tax.

The service sector first saw the tax in May last year when it was applied to property, financial and consumer services sectors. At the same time, VAT was extended fully nationwide.

Authorities say that between then and June, the switch to VAT has saved businesses 85 billion yuan ($12.8 billion) in taxes, providing an important boost to the ‘rebalancing’ of the economy towards consumption. Total tax savings since the pilot scheme started is put at 1.6 trillion yuan.

In July, the four VAT brackets (17%, 13%, 11% and 6%) were reduced to three with the elimination of the 13% bracket. Agricultural products, tap water, publications and several other ‘13%’ goods were moved down to the 11% bracket, though that still leaves more VAT tiers than the international average.

The new plans foresee digitization of the tax system, simplifying procedures for tax filing and switching from physical to electronic versions of the invoices-cum-receipts (fapiao) that serve as legal proof of purchase for goods and services. Fapiao are a key component of enforced compliance with China’s tax law as they compel companies to pay tax in advance on future sales.

The VAT fapiao is also used for tax deduction purposes within VAT, so digitising the whole process should streamline the accounting.

The tax is still referred to as “the VAT reform pilot program” though that status as a pilot looks like ending de jure as well as de facto; the State Council executive meeting also indicated that more detailed national VAT legislation would be forthcoming.

There is more work to be done on standardising it as a national tax. There are still inconsistencies between sectors in the rates applied to the same goods and services. Also, some tax payers are not able to make full VAT deductions. A further issue to address is compliance costs for taxpayers with multiple business locations.

One major issue that a national VAT does not address is how the tax take is shared at the provincial level. (Germany and Japan, for example, use allocation rules based on population and aggregate consumption, respectively.)

However, China has a bigger problem of fiscal redistribution to tackle. The country has the largest share of local government spending in the world, largely because public services and the social safety net (health, education, welfare, etc.) are centrally mandated but delivered and paid for at the local level. Many federal countries decentralise their social insurance system, but China is a rarity in having both its public pension system and unemployment insurance managed at the local level.

Yet, since the fiscal reforms of 1994, provinces and municipalities have negligible revenue raising powers of their own. Further, although 60% of taxes are collected by local government, those taxes are handed over to central government with some to be returned via revenue-sharing and other transfer schemes through rules that are still not completely transparent.

Transfers from the central government were supposed fully to finance local-government deficits since provinces and municipalities were barred from issuing debt.  In practice, however, local governments were given increasingly large unfunded mandates. Because of the prohibition on issuing debt, they resorted to selling land and using off-budget special-purpose vehicles to borrow and spend on infrastructure, starting the infamous local-government debt bomb ticking.

Local governments debt had reached the equivalent of around 40% of GDP by 2015.

A fiscal reform plan was announced in 2016 to address the misalignment, but it will take a comprehensive imposition of taxes such a market-value-based property tax, local surcharges to personal income tax and maybe even an additional provincial-level VAT — though that is difficult technically to administer; few if any countries have pulled it off.

It will also mean converting the pilot scheme for issuing and trading municipal debt started in 2014 when back door borrowing through special-purpose vehicles was banned, into a national muni-bond market. That, in turn, will require broader financial-system reforms.

Those are proceeding at a cautious, measured pace. Short-term stability and state-centric control is the current leadership’s instinctive approach. That may change after the forthcoming Party congress, but, more likely, it will not. In that context, streamlining VAT to puts greater taxation capacity in Beijing’s hands makes political as well as economic sense.

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China’s ‘Achilles’ Heel’ Of Debt

THE IMF’S LATEST Article 4 consultations report on China’s economy retraces some well-trodden ground. While edging up its projections for China’s growth projections, the Fund again underlines the growing risk from debt in the medium term.

Arguably this is the greatest macroeconomic risk that China faces and which the Fund says needs to be addressed now if sustainable growth is to be sustained. It summarises that risk in a supplementary note to the main report thus:

International experience would suggest that China’s credit growth is on a dangerous trajectory with increasing risks of disruptive adjustment and/or a marked growth slowdown.

Managing the debt issue is inseparable from rebalancing the economy, away from infrastructure investment and export-led growth to domestic consumption.

Progress in rebalancing, the Fund acknowledges, is being made, particularly in reducing industrial overcapacity. Borrowing by local governments is being made more transparent, and regulators have started to address financial sector risks.

The Fund, though, calls, as it has repeatedly done in the past, for the pace of reforms to accelerate, taking advantage of the relatively robust growth the economy is now enjoying.

Its check list of five action points will be familiar:

  • boost consumption by increasing social spending by the government and making the tax system more progressive;
  • increase the role of market forces by reducing implicit subsidies to state owned enterprises and opening up more to the private and foreign sectors;
  • deleverage the private sector by continuing the recent regulatory tightening in the financial sector and greater recognition of bad assets in the financial sector;
  • ensure macroeconomic sustainability by focusing more on the quality of growth and less on quantitative targets; and
  • improve policy frameworks so that the economy can be better managed.

The fund particularly recommends accelerating the reform of state owned enterprises by moving social functions away from them and opening their protected sectors to more private and foreign competition.

There will be a cost to that which will strain the financial system. Bankruptcies will rise with the elimination of blanket state guarantees and lenders that have made uncreditworthy loans will get into trouble. The political concern is that strain on the financial system turns into social stress.

IMF China reforms scorecard August 2017

As this Bystander has noted before, policymakers have been steadily if cautiously managing down the GDP growth rate for several years, mostly by reducing too high investment and too rapid credit growth. They have been less active in opening up replacement sources of growth, notably by opening up to the private sector.

The fund also lays great importance on the need to liberate private savings for consumption by increasing public spending on health, pensions and education, three areas in which its spending is well below the OECD average, and by increasing social transfers to the poor, who are disproportionately greater savers than the poor in other countries,

Again as this Bystander and many others have noted before, the longer China delays tackling the structural underpinning of its debt load, the longer resolving them will take and the greater the risk of not doing so becomes.

This is an opportune moment from an economic point of view to do so. Growth in the first half of the year was more robust than expected with both the global economy and financial conditions being benign. Domestically, the effects of cutting industrial capacity are starting to work through, bolstering profits and areas of the private sector where state-owned enterprises are largely absent, such as e-commerce are showing exemplary dynamism.

Also, balance-of-payments and exchange-rate management have been adept while some old-school fiscal stimulus six to nine months ago has also kicked in.

Markus Rodlauer, deputy director of the IMF’s Asia and Pacific Department, put it this way:

The situation at this point right now…should be used as an opportunity…to bear down and to buckle down and continue with this financial sector adjustment, which is really the Achilles’ heel now of the economy.

Once the 19th Party Congress due to be held in October or November is out of the way, and assuming it has not changed politics appreciably, that may happen more visibly.

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IMF Sees Increases In China’s Growth And Debt

THE INTERNATIONAL MONETARY Fund (IMF) has upgraded both its economic growth forecast for China in 2018 and the downside risks of debt.

In its July update to its World Economic Outlook, the Fund says its projections reflect the strong first quarter growth this year and expectations of continued fiscal support.

It now says it expects growth next year to be 6.7%, the same as this year and in 2016, and 0.1 percentage point higher than previously forecast. Growth in 2018 is expected to slow by 0.2 percentage points less than previously projected, to 6.4%.

This the Fund believes will be because authorities will sustain high public investment to achieve the target of doubling in real terms 2010’s GDP by 2020. This, in turn, implies that debt levels will not be attacked as actively as needed and financial reforms delayed.

The National Financial Work Conference, the high level policymaking agency chaired by President Xi Jinping that concluded its quinquennial meeting on July 15, emphasized that policymakers’ priority was to deleverage state-owned enterprises (SOEs) within its focus on limiting systemic financial risk.

First, though, Xi has to get through the forthcoming Party plenum, which should provide clues to the strength of his position to tackle the politically powerful interests that control the SOEs.

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China’s Growth Spurt Provides Scope To Tackle Debt

TALK OF A hard landing for the economy seems distant, now. China’s economy grew by 6.9% in the second quarter year-on-year, the same as in the first quarter and well ahead of the official target of 6.5%, the National Statistics Bureau reports.

Quater-to-quarter growth quickened to 1.7% from 1.3%. Industrial output (up 7.6% in the first half) and consumption (retail sales were up 11% in June year-on-year) picked up while investment remained strong, suggesting that measures to control the frothy housing market have not yet worked through, or perhaps are not working as effectively as policymakers intended. Property investment increased by 8.5% year-on-year in the first half.

The extent to which property prices cool over the rest of the year will be closely watched. If they do, despite the solid underpinnings of the recovery, the growth rate may moderate in the second half, though not to the extent the official target will be threatened.

The long-term build-up of structural imbalances, manifest in the growing levels of debt, remains, but the latest growth figures give the leadership some scope for pushing through financial reforms at the party plenum later this year.

Some of those, notably the expansion of bond markets to allow direct financing of local governments and enterprises in place of policy lending by banks, will have been thrashed out at the two-day National Financial Work Conference that ended at the weekend.

That this quinquennial meeting chaired by President Xi Jinping was convened a year late this time indicates how politically contentious economic reform remains, not least because they also intend to rein in the debt of state owned enterprises, themselves powerful political fiefdoms.

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OECD Sees China’s Economy Stabilising But Reform Still Needed

THE OECD QUIETLY prides itself on being the grown-up economic forecaster, eschewing the flash and razzmatazz of the International Monetary Fund or the World Bank for an understated mix of solid economic analysis and policy prescription.

The chapter on China in its latest Economic Outlook fits the bill to a tee: a sparse summary of an economy that is stabilising thanks to earlier policy support, but still needing structural reform if ‘rebalancing’ is to be advanced.

GDP growth for this year is forecast to be one-tenth of a percentage point above the official target of 6.5% and the same below in 2018 — ‘holding up’ despite considerable excess capacity remaining in the industrial sector. Consumption remains robust supported by housing-related purchases, e-commerce and overseas tourism.

While infrastructure investment is being sustained, monetary policy is tightening in response to the risk of financial instability, particularly via the shadow banking sector, and other risks that are mounting. Fiscal policy remains expansionary, however. The headline fiscal deficit will be held at 3% of GDP this year and next, the OECD reckons, but policy lending to prop up growth will also slow the rate of rebalancing.

That will also be slowed by the lack of reform, for example to the social safety net, that is diverting monies that individuals could spend on domestic consumption to precautionary savings. Longer term, the OECD says, corporate deleveraging and working off excess capacity “will be crucial to avoid a sharp slowdown in the future.”

It also quietly but firmly makes the point that longer the debt problem is left unaddressed, the larger it will get, and, by implication, the harder it will be to deal with it.

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Politics, Not Debt Will Drive The Deleveraging Of China’s SOEs

MOODY’S CREDIT DOWNGRADE of China caught the attention of the public prints, ever ready, in some quarters at least, to see the prophesied hard landing just around the corner, with the economy crumpling under the weight of an oncoming rush of bad debt. S&P did much the same as Moody’s back in March with much less general notice. In its commentary, Moody’s falls over itself to emphasise the long-term nature of the risk.

As this Bystander has argued before, while China’s debt-to-GDP ratio is large, and has grown in recent years, it remains manageable by Beijing, even in the event of a crisis, and the risk of external contagion is small.

That is not to say it is not of concern to policymakers. It is. It is concentrated in state-owned enterprises (SOEs) and local authorities. SOE debt, at 115% of GDP is concerning. (In Japan and South Korea state-owned corporate debt is about 30% of GDP). And the finance ministry has noted that some local authorities, caught between paying for shutting down loss-making state industries or subsidising them to keep them going, and no longer able to rely on land sales to square their books, are struggling to cover operating expenses.

All this is also a sign, widely commented on by the likes of the IMF, World Bank and the OECD, that the old-school means of state-led infrastructure investment to keep growth going are persisting to the detriment of ‘rebalancing’.  Those two points come together politically.

The political event of the year is, self-evidently, the Party plenum to be held later this year. This is no ordinary plenum, as it is the scene-setter for the next generation of leadership. President Xi Jinping’s legacy is at stake.

Vested interests lying in the way of economic reform have not been fully removed by the anti-corruption campaign. Many of those same interests would also end up on the wrong side of any aggressive debt resolution, given both the individual companies that would be involved and the structural reforms necessary to governance and financial markets.

So, for now, authorities are biding their time over the debt question. The economy has stabilised sufficiently to buy them a few more months of inaction; candidate Trump’s threatened trade war has been headed off; the razzmatazz around One Belt, One Road sustains hopes of new export markets for excess capacity.

Once Xi has consolidated his political control at the plenum, then the debt busters will start to move in.

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