The pundits ponder the “New Normal”

ECONOMIC OUTLOOK

The pundits ponder the “New Normal”

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Mizuho Securities Asia on China’s early 2017 economic outlook

Based on a significant rebound in 10 leading economic indicators, we believe the pickup in China’s economy starting in 2H 2016 is continuing into 1H 2017. Increasing PMI, SMI, and new yuan loans to the corporate sector show that manufacturing industry is on a recovery track. The rebound in new housing starts suggest that a turning point in the real estate market is yet to come due to lagging effects following cooling measures. Strong PPI, railway freight, coal consumption, steel production, heavy truck sales, and excavator sales are all evidence of solid government-supported investment centering on infrastructure investment. We expect steady economic growth in the first half of 2017, both directly via infrastructure and indirectly through positive spill-overs to related manufacturing industries, supported by government stimulus. However, we think the downward pressure on the economy will become stronger in 2H 2017.

Louis Kuijs of Oxford Economics on the RMB

This year we expect policymakers to continue their policy of containing outflows in order to limit the decline in FX reserves. However, as the pressure for financial outflows is likely to remain high, existing policies may not be enough. As we estimated in the attached, to achieve stable FX reserves financial capital outflows will eventually have to fall by around US$ 450 billion on an annual basis, compared to the pace of outflows in 2016. To achieve such a turn-around, policymakers may eventually have to resort to more forceful steps such as formally re-imposing restrictions on outflows or re-introducing rules on the sale of US$ receipts by exporters on the domestic FX market.

UBS’ Wang Tao on 2017 economic start

February manufacturing PMIs showed improved momentum post the Chinese New Year, with better new orders and new export orders, stronger production momentum, improved raw material inventory, and slightly weaker but still firm input price momentum.

Both NBS and Caixin’s manufacturing PMIs rebounded in February to a robust reading of 51.6 and 51.7, respectively. Manufacturing activity gained some traction last month post the Chinese New Year (CNY), with better new orders and new export orders, stronger production momentum, improved/less bad raw material inventory, and slightly weaker but still firm input price momentum. Both PMI surveys also showed manufacturing output prices picking up as well on the back of strong upstream prices. February’s NBS non-manufacturing PMI softened slightly albeit to a still strong reading of 54.2, of which logistics, railway transport, IT services and financial services’ subsector-indices all expanded at a solid pace.

The NBS PMI implies that January and February (Jan-Feb) manufacturing activity momentum held up thanks to stronger demand and production, propped up more by larger-sized enterprises as their small & medium peers continued to underperform. Power generation likely strengthened, as suggested by large Chinese IPPs’ faster pace of coal consumption. Chinese steel furnaces operated at around the same average rate in January and February as they did in December; as did crude steel production. Together with last year’s low base, we expect Jan-Feb’s industrial production growth to have picked up to 6.4%y/y.

High frequency data saw property sales in 30 major cities contracting at a slower pace of -21%y/y in Jan-Feb, better than December’s -24%y/y. Property sales in some tier-2 and lower tier cites without property tightening have also reportedly been strong. Combined with last year’s high base, we therefore think Jan-Feb’s national property sales likely held up around 10%y/y (vs 11.8%y/y previously). Growth of new starts may have moderated slightly on last year’s high base. Overall, we expect property construction to have edged down, and for real estate investment to have moderated to 5-10%y/y.

Infrastructure investment likely picked up thanks to a reportedly solid pace of local public project implementation and strong credit support in early 2017. Manufacturing investment probably held up, given improving industrial profits and corporate confidence. We thus expect overall FAI growth to have rebounded to 8.8%y/y in Jan-Feb, from last December’s 6.3%y/y and 2016’s 8.1%.

Fiscal policy is expected to remain supportive, with budget deficit likely expanding slightly from last year’s 3% to 3.5% of GDP (accrual basis), though most spending will likely continue to be backed by quasi-fiscal channels like PPP. We expect local government debt swaps to continue, likely totaling over RMB 5 trillion in 2017.

Monetary policy will likely stay “prudent and neutral” with a tightening bias. We expect both the M2 and official TSF growth targets to be lowered to 11-12%, and for our adjusted TSF credit growth to soften slightly from last year’s 16.1% to around 15% in 2017. The PBC emphasized the need for “prudent” and “neutral” monetary policy rather than just “prudent” as before in its Q4 2016 monetary policy report. With the government still pushing for financial deleverage and increased risk control, domestic inflation expectations still rising, and RMB depreciation pressures persisting (though temporarily eased), this signals a continued tightening bias for Chinese monetary policy. That said, we still expect credit policy to stay accommodative enough to support economic growth.

Financial regulations are expected to be enhanced and better coordinated. Starting Q1 2017, banks’ off-balance sheet WMP products are included in the PBC’s quarterly MPA assessments, something that may restrain interbank credit expansion to slow overall WMP growth, with a likely greater effect on median & small-sized banks. The PBC has also reportedly moved to unify existing regulations under various authorities for different financial products (e.g. CSRC, CBRC, CIRC), possibly to include Certificate of Deposits (CDs) in interbank liabilities. In addition, the senior leadership also called for improving financial regulation coordination yesterday. We think that above policy signals make clear that financial deleverage and risk control remain as a policy priority, and these regulatory moves should help to minimize arbitrage/evasion of financial regulations, but likely be implemented in a gradual manner.

Curtailing property bubble risks should remain a policy priority. Local governments are likely to implement additional tightening measures to contain speculation demand, including administrative controls to prevent rapid price increases, but policies will stay differentiated across different cities. The legislative process for the long-delayed property tax may accelerate, but unlikely be implemented in 2017.

Supply side structural reforms may gain more traction. We expect:

• Excess capacity reductions to be pushed forward further in the coal and steel sectors and expanded to other sectors, with closure of “zombie companies” a key initiative. However, 2017 targets for the coal and steel sectors may fall short of 2016’s total achieved capacity reduction;

• Rural and agricultural areas to see more supply side reforms, via agricultural production scale operations, greater rural infrastructure investment, more incentives for new rural services/businesses, boosting rural household income by strengthening protection of rural land rights;

• SOE reforms (in particular mixed-ownership) to be pushed, especially in state monopoly sectors such as power, oil & gas, railway, civil aviation, telecom, military industries;

• More debt restructuring assisted by local AMCs and use of debt-equity swaps, but no wholesale recapitalization;

• Tax reductions to continue for small & micro business and selected emerging sectors;

• Corporate social security contribution to be lowered again, likely saving corporates over RMB 100 billion this year.

Mizuho on China’s hidden fiscal expenditure

In the Government Work Report of 2017, the fiscal deficit target was set at 3% of GDP, similar to last year. However, we believe the government has other spending channels for its proactive fiscal policy set out in the Central Economic Working Conference. In fact, we note that China’s actual fiscal deficits and actual government liabilities could be significantly higher than official figures suggest. In our view, Government Guiding Funds (GGFs) and Special Construction Funds (SCFs) are two such hidden channels of government expenditure.

Economic Information Daily reported on 1 March that by the end of 2016, 1,013 GGFs had been established by different levels of governments, with total capital of more than CNY1.9t. Moreover, some local government websites have also recently suggested that the NDRC has approved the seventh round of projects supported by Special Construction Funds (SCFs). It is estimated that these projects would receive more than CNY200b capital from SCFs. We believe GGFs and SCFs will likely play an important role in supporting economic growth in 2017. Of course, the implicit fiscal deficit, direct and contingent government liabilities would increase as well.

China’s first GGF was established in 2002 at Zhong Guancun, a high tech centre in Beijing. Such funds are designed for investment in risky or long-term projects that market-oriented funds may not be willing to participate in directly. For example, GGFs can serve as venture capital and invest in high tech firms at an early stage. They could also provide capital for long-term infrastructure projects as well, including Private Public Partnership (PPP) projects. GGF funds usually consist of two tranches and can bring additional leverage. Money coming from government budgets is usually the junior tranche, while funds from financial institutions and social capital constitute the senior tranche. If the investment fails, the government money serves as a cushion and can reduce the risk for private investment; if the investment is successful, the government investment is not profit driven and only requires a fixed and limited return, so the return for the private investment can increase significantly.

Louis Kuijs of Oxford Economics on trade figures

As expected, headline trade data was strong in January. Exports posted their first increase in US$ terms since March last year, boosted by the timing of the Chinese New Year.  Import momentum remained solid, following the impressive sequential run up last year, indicating continued steady domestic demand momentum and higher commodity prices. That said, we remain cautious on the outlook for both global demand and Chinese domestic demand later in the year.

Headline goods exports rose a healthy 7.9% y/y in US$ terms in January, the first month of headline y/y growth since March 2016. The caveat is that trade is bumpy in the first months of the year, especially exports, due to the varying timing of the Chinese New Year (CNY) holiday. With most of the CNY holiday falling in February this year, exporters are likely to have pushed out shipments in January before closing for the holiday. Based on our estimates of price developments, goods export volumes were up 12.2% y/y last month from a relatively weak base while the 3mma seasonally adjusted monthly export volume accelerated impressively, pointing to improved momentum going into 2017. Nonetheless, with the climate for China’s exports to the US undeniably getting harsher this year under the Trump administration and risks of more broad damage to global trade, we remain cautious on the export outlook later in the year.

Goods imports posted a 16.7% y/y increase in US$ terms in January. With import prices in US$ terms having picked up significantly in recent months due to the rise in commodity prices, we estimate that goods import volumes rose a hefty 13.7% y/y. That was to be expected, given the strong run up in the sequential data throughout 2016 (see Chart). Nonetheless, the sequential 3mma month-on-month momentum remained healthy in January. Indeed, given this recent history and the recovery in commodity prices, headline import data is bound to remain solid in the coming months. The strong import data points to robust domestic demand in China at the beginning of 2017. However, the ongoing housing market correction and lower credit growth are likely to weigh on import growth in the year ahead.

Capital Economics on the rise in China’s Forex reserves in February

The rise in China’s foreign exchange reserves last month suggests that the People’s Bank purchased foreign exchange in February and that capital outflows stalled. But the picture is murkier than usual around Chinese New Year, when port and bank closures disrupt both trade and financial flows.

The value of China’s foreign exchange reserves amounted to $3,005bn at the end of February, up $7bn from a month earlier, according to data just released. The increase was the first since last June and was unexpected. Every economist polled by Bloomberg, ourselves included, had expected the value of the reserves to fall (the Bloomberg median was $2,969bn, our forecast was $2,960bn).

Our model suggests that valuation effects from fluctuations in exchange rates and bond prices should, if anything, have reduced the value of the reserves. At face value then, it appears that the People’s Bank (PBOC) purchased rather than sold foreign exchange last month for the first time since October 2015.

How big a deal is this? It is certainly a striking shift and one that, potentially, could create tensions with the Trump administration. For February at least, the charge that China has been intervening to weaken its currency, may be justified. The US Treasury’s next Currency Report, in which it identifies whether trade partners manipulate their currencies, is due next month.

But we’d be wary of making too much of the apparent reversal. It may be that our estimate of valuation effects is flawed and that the PBOC has continued to shed foreign assets. It’s also possible that the PBOC has shifted assets from other parts of its balance sheet into the official reserves, giving them a boost. Things will become a lot clearer once the PBOC publishes its balance sheet data later this month.

The FX data also suggest that capital flows diminished sharply or even dried up altogether last month. After all, the trade surplus is very likely to have fallen in February.

As much as we believe though that the PBOC will ultimately prevail over those expecting a sharp devaluation, we’re sceptical that this is the turning point. After all, in the same way that port closures cause disruption to trade flows around Chinese New Year, so closures of banks and other financial institutions disrupt capital flows. We’ll reserve judgement until the Chinese New Year volatility is out of the way.

Moody’s Investors Service on Premier Li Keqiang NPC Work Report

As in previous years, maintaining economic and social stability appears to be a prime objective of the government in 2017. Economic and social stability are positive for China’s credit profile if they are achieved in a sustainable manner. Stability in the short term at the expense of reforms that would deliver longer-term economic and financial stability would be credit negative. From the policy announcements so far, it is not yet clear what path China will take.

The growth target of ‘around 6.5%, or higher if possible in practice’ points to an adjustment of growth expectations and objectives, albeit a very gradual one. We estimate that China’s growth potential is lower than 6.5%. To achieve this year’s target, fiscal policy in particular will likely continue to be expansive, in line with the proactive fiscal policy stance.

Although the deficit target is set at 3% of GDP, as in 2016, the fiscal impulse is larger. The gap between the government’s revenues and expenditure is likely to be wider before funds are reallocated, as has been the case in the last two years. In 2016, that gap was 3.8% of GDP. Other public sector spending such as investment by state-owned enterprises also contributes to maintaining robust growth. We expect government debt to continue to edge up, towards 40% of GDP from 39% last year and just above 30% at the beginning of the decade. This level of government debt burden is broadly in line with similarly rated sovereigns.

The areas of focus for 2017 mark a continuation of 2016 including reductions in overcapacity, reduction in property inventory and corporate deleveraging. The Work report does not contain the details of implementable policies in these areas. Such measures would bolster China’s credit profile if the objectives are achieved without significantly undermining the strength of the financial system and/or the government’s balance sheet. Prospects for a weaker financial system and/or eroded fiscal strength as the measures are implemented would be credit negative.

UBS on 2017 growth target

The Chinese government set this year’s GDP growth target at “about 6.5%”, in line with expectations and slightly lower than last year’s 6.5-7% target. The government’s annual CPI inflation target has been set at 3%, indicative fixed asset investment target set at 9% and that for retail sales at 10%. General budget deficit is to remain at 3% but overall budget deficit is set to rise.

Despite increased rhetoric on financial risk containment and market concerns about monetary tightening, the government set a 12% M2 growth target for 2017, higher than last year’s actual outcome of 11.3%. The TSF credit growth target has also been set at 12%, implying slower credit growth than last year and a slight tightening bias. We expect no benchmark rate hike and only a gradual tightening of asset management regulations.

Property policies will remain differentiated as the government wants to avoid property market “fluctuations”, suggesting an equal desire to prevent both a sharp downturn and a bubble. The much talked-about property tax is reportedly not in the legislative agenda for this year and hence unlikely to be implemented soon.

After exceeding last year’s target for steel and coal capacity reductions, the Chinese government plans to respectively reduce steel and coal capacity by 50 million and 150 million tons this year. The government also intends to push forward with corporate tax cuts and fee reductions, rural supply side reforms, divestment of competitive functions in some key SOE sectors, debt restructuring, and hukou and related social safety net reforms.

Recognizing downward pressures in the economy whilst making economic and financial stability its most important goal for this year – China’s government set its 2017 GDP growth target at “about 6.5%”, in line with expectations and slightly lower than last year’s 6.5-7%. As we have written before, slower growth is not a big challenge for the labour market per se. Indeed, with over 13 million new urban jobs created in 2016, the government’s new urban job creation target of 11 million this year will likely be exceeded again. Targets for this year’s retail sales and fixed asset investment growth were set at 10% and 9%, respectively. Meanwhile, despite PPI’s sharp increase in recent months and even with planned electricity and utility price reforms, the government’s goal to keep CPI inflation at around 3% is easily achievable as PPI momentum will likely peak soon and transmission from PPI to CPI will likely stay weak.

This year’s softer growth target of around 6.5% signals the government’s intent to balance a need to maintain solid growth on the one hand and the need to contain rising leverage plus related financial risks on the other. To achieve its growth target, the government will have to continue providing fiscal/infrastructure support, financed by further credit expansion. That said, both fiscal support and related credit expansion will likely be slightly less than in 2016 – indeed the government’s TSF growth target has been set at 12%, slightly below last year’s outcome. A more positive inventory cycle and recovery in global demand should also help China’s overall growth this year. We expect China’s real GDP to grow by 6.4% in 2017, with nominal GDP growth exceeding 9%.