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China 2016 - A tough balancing act

On 19 April 2016 the ECCT's Greater China Business committee hosted a lunch featuring guest speaker Tony Phoo, Senior Economist at Standard Chartered Bank Taiwan. Phoo gave his views on the outlook for mainland China's economy based on his bank's research, which includes data drawn from forums with its clients in 15 different markets in recent months.

The fact that most of the bank's clients surveyed recently are engaged in manufacturing or related businesses appears to have influenced the results because mainland China's slowdown has become the top concern for them in 2016. Standard Chartered's analysis of the situation is more nuanced, and slightly more positive. The bank has tended to have more positive forecasts than other parties. (Its GDP forecasts for mainland China for 2016 and 2017 are 6.8% and 6.7%, respectively).

Looking at the underlying data, pessimism on the part of clients is not surprising. Mainland China's production data, including freight traffic, industrial production, electricity production, cement and steel output growth, which had been falling since 2010, are now contracting on an annual basis. Moreover, leading indicators including manufacturing Purchasing Managers' Indices (PMI) are now officially in contraction mode, indicating further declines in output ahead (although it is yet to be seen if a slight improvement in March data signals a better outlook than previously expected).

In its latest five-year plan, Chinese authorities have set a target to double economic growth from 2010 levels by 2020 (which translates into over 6.5% growth every year from 2016 to 2020). 2020 is an important year for the authorities as it will mark the 100th anniversary of the Chinese Communist Party (CCP). The targets for a rising deficit as a percentage of GDP to 3.3% in 2016 and 3.5% in 2017 signal that authorities are willing to spend to boost the economy.

However, there are apparently contradictory aims in the latest five-year plan. While authorities talk about reforming State-Owned Enterprises (SOEs) and deleveraging, which is contractionary, at the same time they want to maintain high economic growth and increase the M2 money supply, which is expansionary.
In terms of monetary policy, authorities talk about maintaining a stable currency while moving forward towards internationalization of the renminbi/Chinese yuan, which, if left to market forces, is more likely to be volatile than stable. There is also an apparent disconnect between the aim of prudent fiscal policy and pro-growth policy. The economic slowdown coupled with often competing aims has made investors nervous, which has led to a large amount of capital outflow, especially since the second half of 2015.

However, according to Phoo, there are several reasons to be optimistic. Firstly, the process of urbanization still has a long way to go in China. With urbanization comes more investment, more value-added activity and higher economic growth. Secondly, while there is much hand-wringing about China's demographics (a rapidly-aging population, shrinking workforce and falling demographic dividends), very little has been said about how much potential there is to improve productivity. In Phoo's view, China is still in the early stages of this evolution and productivity could be boosted in many areas, such as in SOEs.

Thirdly, China's shift from a manufacturing to a service-based economy is proceeding faster than some people realise. According to Phoo, the contribution to GDP of the tertiary or services industry (which includes the hospitality, logistics, real estate, finance and retail industries) overtook that of secondary industry in 2012 and already accounts for 55% of GDP. Along with the rise in services comes greater consumer purchasing power. In terms of consumer spending, China is behind many of its neighbours and far behind the West but the rate of growth in consumer spending is faster in China than elsewhere, meaning that China is catching up. Fourthly, China's so-called "one-belt one-road" and Asia Infrastructure Investment Bank initiatives will give some breathing room to China's manufacturers, particularly in the steel and cement industries. Massive infrastructure projects overseas will help to absorb some of the huge stockpiles and overcapacity produced by these industries while allowing them to restructure and reduce production capacity gradually.

Turning to the issue of debt, while China's level of corporate debt has risen sharply in recent years, China's overall debt, at 283% of GDP, is not that high compared to Japan's 517%, the UK's 435%, Spain's 402%, France's 374%, Italy's 335%, Greece's 321% and South Korea's 286%. Moreover, for Phoo, what is more important than the level of debt is the ability to repay debt. In this regard, China appears to be in fairly good shape given that state assets (held by the central and local governments) more than cover the amount of total liabilities, even when stripping out the value of land. In addition, as only 9% of China's debt is to external parties, there is relatively limited exposure to foreign creditors. For these reasons Phoo believes that market watchers are overly concerned about China's debt.