Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Country Briefing Notes – China


Dec 2 2014

• China has started implementing monetary stimulus measures to boost growth and avoid
deflation
• Contrary to the Chinese government’s restrictive monetary policy model, China recently
took its first step towards loosening its monetary policy and giving its slowing economy
some much-needed stimulus
• On Friday, November 21, the People’s Bank of China cut the one-year lending rate from
6% by 40 basis points to 5
...
The move was an attempt to refuel the economy
...




















• Economic indicators in China are telling a different story these days than they did a year
back
• October readings indicate that China’s growth slowed to 7
...

Industrial production (or factory output) growth figures that came in recently at 7
...
1%
...
5% - the slowest pace since early 2006


























•

•
•


















Macroeconomic issues surrounding China The chart above depicts the economic issues
surrounding China currently
...
4% in 2010)
...

Inflation levels have sunk In China Inflation levels in China sunk to 1
...
The rate
marked the lowest price level rise over the last five years (since November 2009)
...
CPI is the main inflation indicator in most countries
...
Analysts expect further declines in the next few quarters
...
This leads to an increase in the purchasing power of a
currency
...

Declining producer price index Producer prices, charged at the factory rate, have been
falling for almost three years, piling pressure onto manufacturers, as consumer inflation
is also weak
...
8% in its 31st consecutive month of
decline
...

China’s low inflation levels also signal that the economy has slowed
...







•

•
•

Growth slowdown in China China’s annual growth has slowed to 7
...
5% for this year
...
5% sometime in 2016, and the World Bank expects
China’s growth to slow to 7
...
The need of the hour is for China to transcend its
state-driven credit-fueled boom towards a more sustainable, consumption-centric
model
...

Chinese President Xi Jinping said in a speech on November 9 that China’s economy is
shifting to a “new normal
...

Below are two possible interpretations of Jinping’s comment
...
China currently needs to shift its revenue model
...
A boost in external demand from the US recovery
will also help support these efforts
...









•

•

Shadow Banking and credit-driven growth in China
The record credit expansion in China has reached its peak
...
One of the reasons for this unprecedented rise in credit
is the shadow banking system in China, which is becoming increasingly prominent
...





The credit boom in China Credit in China has grown by about 2
...
Overall credit in China has ballooned from $9 trillion to
$23 trillion over the last five years
...
The overall credit-to-GDP ratio has surged from
about 147% at the end of 2008 to over 250% this year in June
...
The proportion of non-loan credit extended by nontransparent NBFCs (non-banking financial corporations) has been on the rise
...
This suggests not only that more credit
is going to weaker borrowers that can’t afford bank lending, but also that institutions
with sub-standard risk assessment and limited loss-absorption capacity are becoming
increasingly relevant players in China’s financial space
...
However, while tightening measures aim at decreasing liquidity in
the economy, they may at the same time increase the risk of default—especially on
credit that falls under the shadow banking system
...
There are two main reasons why the real funding cost has been
rising in China in recent months
...
They would
charge a higher nominal interest rate for selected borrowers to provide for the
additional risk attached to their limited creditworthiness
...
So, for a given nominal interest rate (on credit),
the real cost of borrowing (nominal interest rate less inflation rate) has been rising
...
The authorities decided on further
policy actions to counter the slowdown
...

The news of the rate cut by the People’s Bank of China (or PBoC) marks a change in China’s
central bank approach
...
It had been channeling credit to sectors that it deemed important for China’s
growth, including small and rural businesses as well as government-financed low-income
housing projects
...




China requires a change in approach
An economy-wide interest rate cut usually benefits investments as well as consumption in
China
...
So investments inflated while
consumption shrunk, leading to unbalanced growth
...
China’s big stimulus plan to respond to the 2008 financial crisis
saddled the country with debt and wasteful projects
...
The country’s debtto-GDP (gross domestic product) ratio was already over 250% this year in June
...
2 trillion at the end of 2013
...
1 trillion in the US, this speaks volumes about China’s debt position
...

By western standards this is remarkable
...
5%
...

In particular, the growth rate combined with a population of over 1 billion has caused serious
environmental problems
...
A
negative externality is a cost imposed on the rest of society as a result of receiving the benefits
from growth
...

3 Pollution
...
Increased car ownership has led to
problems of smog and worsening air quality
...
Often regulation of pollution is very limited with untreated sewage often been poured
directly into rivers
...
Shortage of Power
...
This has led to the creation of projects like the Three Gorges Dam
...
Environmentalists fear that
the dam will severely impact on the natural habitats of many species
...
Growing Income Inequality
China’s economic growth has benefited the south and eastern regions more than anywhere
else
...
The agricultural north has,
by contrast, been left behind
...
Therefore, this has
encouraged a migration of workers from north to south
...

4
...
Especially
in Beijing and the south East, houseprices have increased significantly
...

5
...

In particular the Chinese banking sector has a bad reputation for making bad loans
...
This is a legacy of the Communist intervention in industry
...
As a
consequence it is difficult for genuine new starts to get sufficient capital funding
...

6
...
The reason is that there are still many state owned enterprises which are grossly
inefficient
...
There is also a lot of unemployment (and disguised unemployment)
in the agricultural sector
...
Undervaluation of Yuan
...
As the dollar had devalued the Yuan has also
devalued
...
The impact of an undervaluation of the Yuan is that:
• Increase inflationary pressure in the Chinese economy
...

• Give an artificial advantage to Chinese manufacturers
...
Overheating Economy
...
This is particularly a problem because of:
• relatively loose monetary policy
• undervalued exchange rate
• Property Boom
...
8%, but, there are upward pressures
...
Huge Balance of Payments Surplus
...
But, the US sees it as creating a great
disequilibrium
...





Correcting China’s Macroeconomic Imbalances

The correction of microeconomic distortions in countries with persistent current account
imbalances is a central precondition for global macroeconomic rebalancing
...
In particular,
underdeveloped public social safety-net systems and a repressed financial sector are commonly
blamed for excessive saving
...
China’s current account surplus has come
down from a remarkable 10
...
6 per cent in 2012
...
It seems to be driven by a decline in
external demand and a boost in public investment rather than changes to the country’s
perennial development model
...
Further fiscal and monetary stimulus followed in response to the
anemic international demand caused by the great recession in the United States and the debt
crisis in Europe
...
7 per cent
of GDP in 2007 to about 48 per cent in 2012, while the savings rate remained above 50 per cent
of GDP throughout, thereby shrinking the current account surplus
...

Interest rate reform would also improve the accessibility to finance for privately owned small-
and medium-sized firms, many of which currently face financial constraint in the formal banking
sector because of the lending rate floor or loan quotas imposed by the People’s Bank of China
...

While we find that increasing social protection expenditure increases national saving for
industrialized countries, it reduces national saving for developing and emerging economies like
China
...
This may be due to shifts of resources from traditional, more manufacturingoriented, investment-intensive sectors to more service-oriented and less investment-intensive
sectors, such as senior care and healthcare
...

Strengthening social security, healthcare and pension systems will make significant
contributions to structural rebalancing of the Chinese economy
...
Reforms that strengthen
the social safety net such as wider social security coverage and a more accessible public
healthcare system will help discourage precautionary saving and raise consumption levels of
Chinese households
...
Our simulations suggest that China’s current account surplus would
decline significantly if the country increased its healthcare expenditure to a level comparable to
that of Brazil, another fast-growing emerging economy
...
As such, the
plans recently unveiled by the State Council to boost the social safety net programs will not
only help reduce inequality, but also correct macroeconomic imbalances
...
In China, as elsewhere,
microeconomic reforms are important to correct macroeconomic imbalances
...
These changes would also help the country get on a path of
sustainable and equitable development
...

With global growth sputtering, China's central bank has limited room to move, unlike
counterparts in South Korea and Australia which both made surprise rate cuts this week
...
7 percent in the first quarter from 7
...


Instead the onus may be on the government to push structural reforms to help sustain long
term growth in the world's second largest economy
...

The government will instead rely on fiscal policy by boosting infrastructure investment and
cutting taxes to underpin the economy, said Xu, a former central bank researcher
...

"We must stay committed to improve the quality of our economic growth, continue to
implement prudent monetary policy, and make policies more pre-emptive, targeted and
flexible," the central bank said in a quarterly policy report
...

"On policy, the priority now is industrial reform to tackle the problem of excess capacity
...
We expect the monetary
policy to remain intact this year," said Dongming Xie, China economist at OCBC Bank in China
...
6 percent in April,
the 14th consecutive month of year-on-year declines and sharper than a drop of 1
...

China's biggest listed steelmaker, Baoshan Iron & Steel (600019
...

The firm, known as Baosteel, usually sets the tone for pricing by the rest of China's steel sector,
which is currently gripped by a supply glut due to less than expected demand
...
4 percent in April from March's 2
...

Economists polled by Reuters had forecast April inflation to quicken to 2
...
3 percent from a year earlier
...
0 percent in April from a earlier, quickening from the 2
...

"Rising vegetable prices were the main factor pushing up the CPI," Yu Qiumei, a senior
statistician at the statistics bureau, said in a statement accompanying the data, noting bad
weather and lower rainfall had reduced supplies
...
""Prices are now sensitive to any rise
in demand
...

Consumer inflation may quicken to around 3 percent in May, partly because of the base effect,
said Zhou Hao, China economist at ANZ in Shanghai
...

"Monetary policy is likely to stay relatively accommodative as China's economic recovery
remains fragile
...
economist
...
Data this week show it will be a stretch to hit even that
...
Even at its subdued current rate, China's growth is still the envy of most
countries
...
China is faring worse than many had
expected (as recently as 2012, the International Monetary Fund, among others, forecast that
annual growth above 8% would continue until 2017)
...
And there
are fears it could yet turn uglier
...
The law of large numbers (financial, rather than
statistical) applies to nations as well as to companies: the bigger an economy gets, the harder it
is to keep growing at a fast clip
...
Structurally, China’s economy faces headwinds
...
When all
three increase, as they did in China for many years, growth rates are superlative
...
China’s working-age population peaked in 2012
...
Finally, China’s technological
gap with rich countries is narrower than in the past, implying that productivity growth will be
lower, too
...
The single most
important development has been its credit binge
...
This
debt allowed China to power its economy through the global financial crisis but also saddled it
with a heavy repayment burden
...
China’s inventory of unsold homes sits at a record high
...

New property starts fell by nearly a fifth in the first two months of 2015, compared with the
same period a year earlier
...
A period of overheated economic growth tends
to be followed by a correction
...
Working off a credit
overhang can take years
...

Whereas previous leaders propped up growth whenever it slowed, Xi Jinping, China’s president
since 2013, has instead spread the gospel of the “new normal”, by which he means less
emphasis on growth and faster structural reform
...
Changes to fiscal rules have made it harder for local governments to spend
money
...
1% and producer prices
deep in deflation, there is a case to be made that China’s economy, restrained by the
government, is performing below its potential
...
As the cycle turns and policy
changes, the outlook should improve
...
They will cap any rebounds
...
Cycles are inevitable
and this is applicable to China as well as all other economies
...


Part I - A Normal Economic Cycle
A
...
cheap
labor pool with much improved productivity fueled China's export boom
...
As part of industrialization and urbanization, China put huge amounts into fixed asset
investments
...
Fixed asset investments have
been productive in the early years
...
Better ports, roads, transport systems, etc
...

C
...
Its early success eventually drove more capital into export sectors
and fixed asset investment (real estate, construction, etc
...

D
...
With the low
hanging fruits in manufacturing/export wrangled out and obvious infrastructure already
built, oversupply/overinvestment became an issue sometime in the middle of last
decade
...
The growth, overshoot, slowdown (or perhaps, recession) phases are almost
universal
...
But instead of a slowdown, China engaged in a series of policies to extend its economic
boom
...
The central government will do everything to keep the economy from sputtering
...

• Sometime during 2007 China's growth slowed rapidly as U
...
fell apart in the great
recession
...
Both
were highly stimulative to the economy as they were a function of borrowing money
from the banks and throwing it at the problem
...
allocate capital wisely)
...
[2]
• By around 2011, massive misallocation of capital in infrastructure began to surface and
unaffordable real estate prices started to create social unrest
...
However, by then, you have a nation of local
government and private/state-owned enterprises addicted to debt
...
The central government would turn
a blind eye if it kept the economy going
...
[3]
• From 2007-2015, China's debt grew from US$7trn to US$28trn
...
This puts China as one of the most indebted nations in the
world
...
[4]
• Since Xi Jinping took helm, China has been trying to shift its growth away from fixed asset
investment (and debt addiction) to be more balanced and consumption
driven
...

• Personally, I think the huge China stock rally (and bust) since 2014, is a misguided attempt to
stimulate the economy through the wealth effect of a bull market
...
It really should be
the other way around as people are learning now
...
I think Xi
Jinping and the central government is very cognizant of the issues
...
They understand the engines of real estate and
infrastructure is not and should not be pushed further
...
Making matters worse, unlike the last two
decades, money is leaving the country putting pressure on money supply and other major
global economies (U
...
, Japan, Eurozone) are all facing their own set of issues
...






note:
-------------
For the sake of readability, I've glanced over certain important issues
...

[1] As with many developing countries, corruption/bribery is a huge issue in China
...
Misalignment of interest is pervasive in China
...

[2] China for years maintained a 'closed' capital account coupled with financial
repression
...
) is trapped within China's
banking system, blessing Chinese banks with hoards of deposits
...

[3] It is easy to think of China as a state-controlled economy
...
Their
interest can and often do collide with the central government
...
This makes analyzing
China particularly difficult
...

Annual consumer inflation eased to 1
...
3 percent and the previous month's 1
...

The producer price index (PPI) stayed unchanged at a negative 4
...



Economists say weak producer prices are of particular concern as commodity prices - a major
deflationary force at China's industrial heavyweights - are recovering yet producer prices
remain depressed
...

China cut interest rates for the third time in six months in May - on top of two reductions in the
amount of money banks must keep in reserve, with little impact on deflation
...


BOOM TIMES OVER
In an environment where returns on investment are usually lower than the nominal 5
...

Indeed, some say the only measurable impact the easings have had is in the stock market,
which has more than doubled since China began cutting interest rates in November
...
It is engaged in a 1 trillion yuan debt swap intended to shore up finances
at heavily indebted local governments, by exchanging their high-yield debt for low yielding
municipal bonds
...
7 trillion yuan of fiscal
deposits
...







---