China: FX Flows and Addressing Weaker Q1 Growth

Published on March 18, 2016

China’s President Xi Jinping presided over a meeting last Sunday during the ten day long 12th National People’s Congress to review macroeconomic measures the government is taking in response to the current economic slowdown. In attendance were Premier Li Keqiang, all the Secretaries of Provincial Party Committees and Provincial Governors, as well as all Ministers of the State Council.

*** Premier Li said economic growth was still running within the “normal range, but warned at the meeting that it was slipping from the initial estimates, with GDP expectations for the first quarter of 2016 now marked down to 6.5-6.6% from the original estimates of 6.6-6.7% and the 6.8% growth rate of the 4th quarter of last year. ***

*** Devaluing the currency to foster growth was not one of the measures discussed or considered. Xi and Li instead both stressed again that the RMB exchange rate will remain relatively stable against a basket of currencies, and that there is no basis for continued depreciation (or for that matter strong appreciation) of the RMB this year. Indeed, from what we understand. The government hopes and continues to expect the RMB to remain roughly between 6.5000 and 6.6000 against the USD this year (see SGH 2/29/16, “China: RRR Cut and the RMB”). ***

*** The leaders did lay out some further measures the government was, and would be, taking to address the pressure and risks to the economy, among them expanding the debt swap quota for local governments, potentially allowing the sale of local government assets, managing industrial overcapacity, cutting property inventory, lowering the provisional coverage ratio for banks, and taking measures to maintain an orderly stock market. ***

FX Flows and Fed Expectations

When it comes to flows and pressures on the RMB, the People’s Bank of China believes the peak seasonal demand for RMB from Chinese individuals may have passed with the conclusion of the February 8-13 Chinese New Year and Golden Week holiday. The PBoC nevertheless expects falling individual purchases of dollars to continue this month, probably to less than $5 billion in March, down from $7.2 billion in February.

And beneath the very welcomed, and less than expected, total monthly drop in FX Reserves in February by $28.572 billion — the smallest monthly decline since last July — PBoC officials were also pleased to note there was a sharp drop in hot money outflows to an estimated $8-$9 billion in February.

They believe the lower than expected hot money outflows were due in part to the RMB steadying as markets take on board Beijing’s policy and message, but also to fading speculative expectations of US interest rate hikes.

Pressures of course remain. Chinese companies for their part purchased $21.7 billion dollars in February, ostensibly to repay their dollar debt overseas. And out of a total trade surplus of $31.9 billion in February, only $12.6 billion is believed to have been converted into RMB from USD.

But the PBoC considers the current levels of the RMB against the USD in the spot market to be reasonable, and expects the RMB to remain close to current level at least for the next couple of weeks.

And according to its FX Reserves report, the central bank predicts capital outflows could continue to slow this spring as the Federal Reserve slows the pace of future interest rate hikes, leaving the RMB against a basket of currencies “stable and relatively strong.”

But beyond currency policy, Chinese policymakers believe they will still need to address continued pressures on growth.

The Key Risks to Growth

At Sunday’s meeting, Premier Li first laid out three challenges facing the country: local governments, especially county-level governments, are facing severe financial shortages; traditional industries such as manufacturing are in a severe recession, and; the housing market is in even worse shape than previously thought in third-tier and fourth-tier cities countrywide.

President Xi then made the following three points:

One, he affirmed that economic growth is the government’s top priority, namely, to ensure growth stays above 6.5% every quarter of this year as planned;

Two, all levels of local governments must accelerate household registration reform to encourage migrant workers to relocate to the third and fourth-tier cities and towns in order to lower housing inventory, and;

Three, all levels of local government must ensure social stability and make sure the quality of life for laid-off workers or early retirement workers does not decline significantly.

Some Macroeconomic Measures

In order to help alleviate the financial strains on local governments, the leaders said the central government has approved a further expansion of the debt swap quota for local governments.

Specifically, Beijing has approved the issuance of a maximum 5.8 trillion yuan quota for local governments to convert maturing high-cost debt into lower-interest municipal bonds in 2016.

President Xi also said the central government will consider allowing some local governments to sell part of their assets if they are facing a severe budget deficit. The local governments, he warned, should however not get into the habit of constantly turning to the central government for financial support.

Alleviating the manufacturing slowdown has admittedly proven to be an enormous challenge as well. In fact, although the central government has set industrial output target for 2016 at 6%, they warn now that actual industrial output is highly likely to miss that target.

Rather than targeting 6%, Li asked all provincial leaders to pay more attention and take more forceful measures to ensure industrial output does not drop below 5.5% this year.

When it comes to addressing the property markets, Xi stressed that the government will take different policies for different cities.

The first-tier cities, especially Beijing, Shanghai and Shenzhen, must take “resolute measures” to prevent the market from overheating and to contain property prices.

Li for his part urged local governments to persuade developers to lower housing prices. He “suggested” that local governments should purchase housing from developers as government subsidized apartments to sell to low-income people.

Both Xi and Li however also warned that no level of local government should encourage real estate agencies to provide credit of up to 20 percent of purchasers’ deposits without any collateral.

Helping Banks and Stabilizing Markets

When it comes to the banking sector the China Banking Regulatory Commission (CBRC) will lower banks’ provision coverage ratio.

The overarching principle being applied is that different banks should be treated differently, depending on their circumstances. Some banks will get their provision coverage ratio dropped to 120% from the current 150%, while some banks will remain with their current ratio unchanged.

Finally, Xi and Li both urged the CSRC (China Securities Regulatory Commission) and other related agencies to work closely together to take care and try to avoid the risk of another stock market slump.

But rather than “goosing” and constantly propping up the markets, they suggested the CSRC should guide individual investors to avoid becoming overly or irrationally optimistic on stocks.

And to underscore that point, the CSRC will refrain from launching a new IPO registration system in 2016.

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