January 2015 | CHINA
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CHINA IN 2015 More Stimulus, Less Growth p.2 Rate Cuts and Yuan Risks p.4 Growth Potential Fades p.6 January 2015 | www.bloombergbriefs.com
Transcript of January 2015 | CHINA
CHINAIN 2015
More Stimulus, Less Growthp.2
Rate Cuts and Yuan Risksp.4
Growth Potential Fadesp.6
January 2015 | www.bloombergbriefs.com
CHINA IN 2015 TOM ORLIK & FIELDING CHEN, BLOOMBERG ECONOMISTS
More Stimulus, Less GrowthCHINA ENTERS 2015 with growth
slowing and the government mov-ing to prevent it from slowing further.
A contraction in the real estate sector is the biggest risk. Resilient exports should put a floor under growth. We expect further rate cuts and an expanded fiscal stimulus to keep the economy on track.
Growth in 2014 is set to come in around 7.3 percent – in the middle of our begin-ning-year forecast range of 7 percent to 7.5 percent. That will be the lowest growth rate since 1990. Alternative measures present a bleaker picture. Bloomberg’s monthly GDP tracker came in at 6.8 percent year on year in November, the fourth consecutive month with a reading below 7 percent.
President Xi Jinping set the tone for the year ahead, saying that 7 percent growth would still make China one of the fastest economies in the world. People’s Bank of China economist Jun Ma forecasts 7.1 per-cent growth in 2015. We think there’s a high chance that the government will set a lower growth target, possibly going down to 7 per-cent from 7.5 percent in 2014.
The consensus forecast for 2015 GDP growth has edged down to 7 percent, from 7.2 percent in the third quarter and 8 per-cent at the start of 2013. We think that looks realistic. We expect growth to come in between 6.7 percent and 7.2 percent depending on the depth of the real-estate slowdown, strength of global demand, and government’s policy stance.
INVESTMENT
The crucial question on the demand side is what happens to investment, especially real estate. Real estate, which drives about 20 percent of GDP, faces serious structural challenges. Current supply is about 10.5 mil-lion units a year. We think genuine demand is less than 8 million units a year. Specula-tors, who used to fill that gap, are parking their cash in wealth management products and money market funds.
The consequence is falling sales. Floor space of property sold was down 10 per-cent year on year in the first eleven months of 2014. Construction of floor space at new projects is already following sales down. In
2015, the sector as a whole could contract, crunching demand for everything from Rio Tinto’s iron ore to Haier’s air conditioning units.
Aiming to prevent contraction segue-ing into collapse, the government is easing policy. Interest rates have been cut and puni-tive costs for second-home buyers removed. Cities have shifted from strict controls on who can buy property to rolling out the wel-come mat. The government may also ramp up spending on social housing to offset the impact of shrinking commercial projects.
The outlook for manufacturing invest-
ment is also weak. High debt, burgeoning overcapacity and uncertainty about the out-look all dent incentives. We expect the gov-ernment to open new areas of the economy to private investment, aiming to offset slow-ing spending in traditional sectors.
Infrastructure investment, driven by pol-icy rather than profits, remains the wild card. Our estimates show China’s 2013 capital stock as a share of GDP roughly in line with the U.S. in 1969. That suggests substantial scope for more productive investments in
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Consensus GDP Forecast Edges Down
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Bloomberg GDP Estimate
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January 2015 bloombergbriefs.com Bloomberg Brief: China in 2015 2
CHINA IN 2015 TOM ORLIK & FIELDING CHEN, BLOOMBERG ECONOMISTS
sustainable energy, public transport, envi-ronmental projects and other priority areas. We expect stronger infrastructure invest-ment to partially offset the slowdown in real estate and manufacturing.
EXPORTS
The start of a new year always brings opti-mism about the prospects for global growth and exports. The International Monetary Fund forecasts 3.8 percent growth for the world economy in 2015, up from 3.3 percent in 2014. Global imports are expected to ex-pand 5.2 percent, up from 3.8 percent. IMF forecasts are typically too optimistic. This year, with plunging oil prices set to provide a boost, they could be on the mark.
A stronger yuan and higher labor costs pose challenges to China’s competitiveness. Those problems have been compounded as other Asian currencies have plunged. China’s real effective exchange rate has appreciated 5.8 percent in the last year. As the world’s largest exporter, China’s ability to grow by tapping new markets is limited. Fading de-mand from emerging markets as the Federal Reserve tightens policy is an additional risk.
We think China’s exports are competi-tive enough to outpace growth in global de-mand, though not by much. That points to nominal export growth of about 5 percent to 10 percent in 2015. Getting a clear read on China’s exports is complicated by the problem of over-invoicing. Exaggeration by exporters can move the headline growth rate by several percentage points.
CONSUMPTION
Rising incomes will continue to propel ro-bust consumption growth. Growth in urban disposable income was 9.3 percent year on year in the first three quarters of 2014. A generational shift – with high-saving older generations moving into retirement and free-spending young generations entering the workforce – is a long-term positive for con-sumption growth. Interest-rate liberalization is boosting investment income.
There are also forces pulling in the other direction. Households face a negative wealth effect from falling real estate prices. A reversal of the end-year rally on the main-land equity markets could dent confidence. The government’s austerity campaign has killed the mood in luxury car show rooms and conference hotels. On balance, though, we think the dominant effect is rising in-comes, and consumption will continue to register rapid growth.
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Manufacturing Real Estate Infrastructure
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Demand Urban Migrants Demand Depreciation Demand New Urban Residents Demand Natural Increase in Urban Population Supply New units
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IMF Forecasts a Better Year for Global Growth
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January 2015 bloombergbriefs.com Bloomberg Brief: China in 2015 3
CHINA IN 2015 TOM ORLIK & FIELDING CHEN, BLOOMBERG ECONOMISTS
Rate Cuts and Yuan RisksCHINA’S ECONOMY HEADS into 2015
with growth slowing and the govern-ment shifting policy to prevent it slow-
ing further. In part two of our look at the year ahead we anticipate more interest rate cuts, an expanded fiscal deficit, and the chance of yuan depreciation.
MONETARY POLICY
The first ten months of 2014 were character-ized by small-scale, targeted stimulus, often using unconventional policy tools and con-ducted in secret. The central bank cut the reserve requirement ratio for banks which lent to small businesses, reduced borrowing costs for real estate developers, and gave China Development Bank a low-price loan to support affordable housing projects.
When that proved insufficient to put a floor under growth, the PBOC changed tac-tics. November’s rate cut marked a shift to the use of conventional tools with a univer-sal impact, and provided a boost to confi-dence from greater transparency.
Even so, conditions remain tight. Bloomberg’s Monetary Conditions Index shows that even after the rate cut the pol-icy stance is tighter than at any time during the last decade. That reflects falling inflation offsetting the impact of the rate cut on real borrowing costs, appreciation of the yuan in real effective terms, and continued slow growth in lending.
Inflation is set to stay low. Plummet-ing oil prices – with a barrel about $53 at end-December – will cut costs across the economy. Overcapacity in industry will con-tinue to weigh on factory gate prices. Food prices are more difficult to predict. On the current evidence though, there’s little indica-tion China’s farmers are sowing the seeds of inflation. CPI came in at 1.4 percent year on year in November. We don’t see immediate pressure for it to rise significantly.
With growth weak, inflation pressure muted and monetary conditions tight, the stage is set for further stimulus. We antici-pate that the central bank will cut interest rates once in the first quarter and once in the second. They could offset the negative impact on savers’ income with greater flex-ibility for banks to pay deposit rates above the benchmark. Rate cuts are typically ac-
companied by cuts in the reserve require-ment ratio. So far the PBOC prefers targeted liquidity injections. Either way, the liquidity taps will be kept open to prevent a cash crunch derailing growth.
A critical question is whether lower rates will trigger stronger lending, or merely allow firms to refinance existing borrowing at lower costs. It’s difficult to see growth stabi-lizing if loan growth continues to decelerate. Concerns about excess leverage will prevent another credit blowout. If bank loans main-tain the current growth rate – 13.4 percent year on year – that implies close to 11 tril-
lion yuan in new loans next year. Shadow banking will likely continue to contract as investors stay away and regulators tighten the rules.
EXCHANGE RATE
A second important question is whether the yuan becomes a channel for stimulus. Structural pressures on China’s currency have shifted. The current-account surplus – once a clear signal of undervaluation – has shrunk from more than 10 percent of
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Corporate and household debt as % GDP (Left)
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High Debt Levels Argue Against Credit Stimulus
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Monetary Conditions Tighter Than Ever
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January 2015 bloombergbriefs.com Bloomberg Brief: China in 2015 4
CHINA IN 2015 TOM ORLIK & FIELDING CHEN, BLOOMBERG ECONOMISTS
GDP in 2007 to 2 percent in the first three quarters of 2014. Falls in the yen and won have left China’s currency looking expen-sive relative to trade rivals. PBOC easing
and Fed tightening are set to narrow the interest-rate differential.
The yuan ended the year at 6.21 against the dollar, down 2.5 percent from
a year earlier. The consensus forecast for end-2015 has started to shift, falling to 6.09 at end-December from 6.0 as recently as end-November. That might still be too bullish. We think the most likely outcome is yuan stability or mild depreciation. The need to avoid capital flight and political wrangles with the U.S. counsel against rapid falls.
FISCAL POLICY
December’s Economic Work Conference set the tone for fiscal policy in 2015, call-ing for a ’proactive and effective’ stance. We think the 2015 deficit may expand to about 2.5 percent of GDP, from about 2.2 and 2.1 percent in 2014 and 2013, respectively. That could pay for higher spending on infrastruc-ture and affordable housing, as well as the continued expansion of the social safety net. Tax cuts for small businesses and strategic sectors are also a possibility.
Low public debt creates space for an expanded fiscal stimulus. China’s debt is equal to 39.4 percent of GDP in 2013, ac-cording to the IMF, much lower than 104.2 percent in the U.S., and 243.2 percent in Japan. Other estimates, factoring in borrow-ing by policy banks and central government ministries, suggest China’s debt load is higher – perhaps close to double the IMF’s estimate. That still leaves room for stimulus.
The new budget law, which comes into force in 2015, changes the landscape. In past years, back-door borrowing by local governments has been a crucial means of funding infrastructure spending. The bud-get law shuts that down and forces local governments to borrow transparently from the bond market. Depending on how rigidly that’s enforced, the impact on local govern-ment finances could be quite severe – in-creasing the need for stimulus spending at the national level.
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CHINA IN 2015 TOM ORLIK & FIELDING CHEN, BLOOMBERG ECONOMISTS
Growth Potential FadesTHE BACKDROP FOR China’s econ-
omy in 2015 is deteriorating growth po-tential. The working age population is
shrinking. According to data from the United Nations, in the five years to 2010 China’s working age population expanded by about 40 million. In the five years to 2015 it will shrink by 6 million. Hukou reform – encour-aging rural workers to linger in urban labor markets – could offset that by boosting labor force participation. Progress has been slow.
China’s capital stock remains an enigma. Attempts to add up the size of the stock suggest it is low, roughly in line with that of the U.S. in 1969. That points to massive scope for continued productive in-vestment. On the other hand, China’s own leaders are blunt in their acknowledgment of excess capacity in traditional industries. The answer seems to be that there is scope for investment, just not in the places where it is currently going.
The final component of growth potential is productivity. In the early stages of Chi-na’s reform era, the majority of productivity growth came from the transfer of agricultural workers into industry. As the surplus of agri-cultural workers is used up, improvements in productivity must come through hard-won innovations. A growing role for the services sector, where productivity gains are slower, is also a negative.
Put it together, and the contribution of labor is flat lining. Capital and productivity continue to add to potential growth, though at a slower rate than before. Bloomberg calculations show potential growth edging down to 7.3 percent in 2015 from 7.5 percent in 2014, on a path to 6.5 percent in 2020. The IMF is in the same range, forecasting a slowdown to 6.3 percent in 2019. The Con-ference Board is more pessimistic, expect-ing average growth of 5.5 percent in the next five years on a scenario of reform failure.
At end-2013, China’s leaders agreed a comprehensive set of reforms intended to sustain medium-term growth. Our as-sessment is that significant progress has been made. A crackdown on corruption has shown the leadership has the muscle to push through tough reforms. A major
stimulus, which would have pushed rebal-ancing off course, has been avoided. There have been concrete wins on interest-rate and exchange-rate liberalization, capital ac-count opening, and a new fiscal framework.
Bloomberg’s real activity indexes pro-vide a measure of progress. The ’old econ-omy index’ – composed of state-owned enterprises, real estate, low-valued-added manufacturing and high-pollution energy – is slowing fast. The ’new economy index’ – reflecting growth of private enterprises, con-
sumption, high-value-added manufacturing, and clean energy – remains resilient.
In the year ahead, we look for contin-ued rapid progress, especially on areas where reform can provide an immediate boost to growth. Interest-rate cuts com-bined with deposit-rate liberalization, local government bonds to pay for infrastructure and social housing, hukou reform to boost property demand, and removing barriers to private and foreign investment all look like potential win-wins.
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China’s Growing Dependence in Global Trade See it in… ECWB <GO
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