China: Message from Above

Published on May 10, 2016

Analysts, in particular western analysts, are struggling to identify the sourcing and thus handicap the significance of an interview with an “authoritative insider” that appeared yesterday on the front page of China’s People’s Daily entitled “China’s Economy Likely to Follow L-shaped Path in Coming Years.”

Beyond the headline message of an optimistic yet decidedly cautious outlook for economic growth, that interview raised eyebrows for its warnings on excess leverage, and its reminder to focus on supply-side reform as well as on growth, all the more so given its “authoritative” sourcing.

*** The “authoritative insider” behind the article was indeed President Xi Jinping himself. From what we understand, Xi authorized Liu He, head of the General Office of the Central Financial Leading Group, to explain China’s current economic situation and outlook to the public. Liu in turn gathered comments made by Xi in government circles into the format of an “interview” to be published by the People’s Daily. ***

*** Yesterday represented the third occasion the People’s Daily published macroeconomic viewpoints from an “authoritative insider,” the other two being on May 25, 2015 and on January 4, 2016, and it reflects a desire by Xi to speak to the public and markets at length on the economy twice a year (yesterday’s report came almost a year from the first article). Chinese officials privately concede that Xi’s comments have on all three occasions at first blush led to a fall in equity markets, but stress that this time around the President’s viewpoints show more confidence in the economy, and they maintain that the economic situation is indeed more stable now than it was at the same time last year. ***

*** Indeed, President Xi and the CFLG expect Q2 GDP to come in at around 6.8%, and as things stand, Chinese officials therefore see no need to adjust monetary or fiscal policy in the second quarter. Rather, assuming the macroeconomic environment continues as expected to stabilize if not slowly improve, Xi and the CFLG will press Premier Li Keqiang and the State Council to turn their focus back to supply side structural reforms. ***

Warning on Debt

Following the headline story from an “authoritative insider” the People’s Daily also published an article entitled “Expert: Supply-side reform needs to be a priority in China’s economy.” That expert, from what we understand, was also Liu He.

Media coverage of the interviews quickly honed in on the unnamed officials’ warnings over leverage and high debt, in light especially of the boom in Chinese credit data over the first quarter. Those warnings included a passage that graphically characterized high leverage as “the original sin” that is the source of financial risk for FX, stock, bond, property, banking and other credit sectors if not managed properly.

But Chinese officials stress three rather more broad takeaways from the 11,000 word opus from Xi in addition to the warnings over leverage.

The first is a reminder and cautionary note that while the economy has had a satisfactory start to 2016, a number of challenges lie ahead, including overcapacity, bad loans, excessive local government debt, a property bubble, and illegal financing. China’s growth is therefore likely to follow an “L-shaped” trajectory at least for the next one or two years, and probably more.

Second is that supply side structural reform should be given greater priority in macro-economic policy at this point in the cycle over simply pursuing demand enhancement stimulus. While challenging, it is a reminder from Xi to still keep the focus on five tasks that have been identified as priorities: “de-capacity, de-stocking, de-leveraging, lowering corporate costs, and improving (financial) weak links.”

Third is to assure the market and public that the leadership is deliberately pursuing a policy that will on occasion mean taking a “step back in order to take two steps forward” in order to ease concerns over its management of downward pressures on growth that may result from the policy efforts¬† to address China’s over-capacity issues, and vice versa.

Of course that nuance is not exactly what markets may have heard, honing in rather on warnings that “high leverage¬† inevitably leads to high risks, which, without proper management, can trigger a systemic financial crisis, cause negative economic growth and even eat up people’s savings. And that is fatal.”

What the real message is intended to say is not that this is the base case, but that rather Beijing is aware, and indeed ready to properly manage those risks.

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