China: High-speed to High-quality Growth

Published on November 22, 2017

Investors and analysts, from commodities traders to US rates forecasters, are concerned and confused on how to interpret the directive from President Xi Jinping to Chinese economic policy officials to focus in the coming years on the “quality of growth,” rather than on the speed of GDP.

These concerns were heightened by comments attributed to a PBoC official indicating a moderation of growth to as low as 6.3%, as China addresses its debt overhang issues, would still be sufficiently high enough for the country to meet its overall economic targets.

*** Investors, however, should not be overly concerned about the degree to which Beijing will sacrifice growth to deflate the debt overhang issues pervading China’s economy. Indeed, far from a 6.3% growth rate penciled in for next year, senior State Council officials currently expect China’s growth, despite some slowdown in October, to come in somewhere between 6.7% and 7.0% next year, on the heels of the 6.9% now expected for 2017. ***

*** A near-term litmus test of China’s policy balance will be in its new loan growth figures. Despite new loans falling more than expected last month to their lowest level in a year, as banks tightened mortgage lending, economic officials expect new loan growth to expand to 1.85-1.90 trillion yuan for the last two months of the year, to hit a high of 13.67 – 13.69 trillion yuan for the whole of this year. That would be more than 1 trillion yuan above the 12.65 trillion yuan in new loan growth registered last year. ***

For the remaining forty or so days of the year, the PBoC will continue to rely on open market operations for liquidity management, with no cuts penciled in either in interest rates or reserve requirement ratios. The central bank will keep appropriate – neither too tight nor too loose – liquidity levels, but will avoid excessive liquidity injections as maturing reverse repos and tax due payments put upwards pressure on market liquidity around year end.

A Healthy GDP Backdrop

China’s top leadership has maintained for some time that the country’s economy will likely experience an “L” shaped” moderation of growth from its previous heady double digit returns rather expecting, or even targeting, a “V” shaped cyclical recovery, if that were even possible or desirable.

Even as Beijing attempts to balance growth with its large, and some would say potentially dangerous, credit overhang, they also stress two broad points consistently.

One is that Chinese debt levels should not be measured, as they typically are, by western standards, given China’s enormous government assets and high private savings rates.

The second is that a moderation from 10-12% to 6-7% growth is hardly a “slow-down,” per se – indeed the nominally much larger Chinese economy generated far more net new jobs at the 6.8-6.9% growth this year than it did when the growth rate was above 10%.

That is not to diminish the seriousness of President Xi and the Chinese leadership’s efforts to address China’s debt issues, led by newly appointed Politburo member, Xi confidante, and Harvard trained economist, Liu He.

Debt levels at many corporate firms remain high, and outstanding Chinese household debt has doubled over the last five years. And the government campaign to discourage riskier lending and reduce overall leverage ratios may contain economic growth. But China’s top economic policymakers still predict a growth rate of between 6.7% and 7.0% for 2018.

Although economic indicators for October were weak, the purchasing power of Chinese households has been increasing, and the increasing competitiveness of Chinese made producers continues to prop up foreign trade. Property prices are expected to continue to moderate next year, but are hoped to settle at more stable levels, and the government will be on alert to ensure there is no real estate investment slump or property price collapse in the makings.

Open for Sales, Tighter on Supervision

On the heels of President Donald Trump’s visit to Beijing this month, China formally announced a major loosening of foreign ownership rules for financial institutions, a move that had long before been planned as a part of China’s five-year strategic development plans.

The timing of the loosening of foreign ownership rules has been also deliberately set to coincide with Beijing’s plans to sell roughly one third of the country’s State-Owned Enterprises over the next five years. Local and national leaders will have tremendous incentive to stabilize those assets as the sales unfold.

In parallel, Chinese regulators are also tightening up on financial supervision, a much-needed measure.

On November 17, five financial regulators led by the PBoC issued draft regulations and guidance for asset and wealth management products across all types of financial institutions, including personal investors, serving as the country’s first unified, and strongest, supervision standard to date for this sector.

These new regulations are seen to be compatible with, and complementary to, the further opening of financial markets to foreign investment, aiming to solve the issues of high leverage, supervisory arbitrage, and to eradicate any notion of an implicit guarantee of potential returns on these products.

These new regulations will not, however, take effect until the second half of 2019. From now until then, July 2019 to be precise, all five of China’s major regulators will introduce and implement a series standardized financial measures that will be transitory in nature.

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