china: kicking the can down the road
TRANSCRIPT
China: kicking the can down the road
Marcus Wright, RBS Economics, April 20161
Information classification: Public/Internal/Confidential/Secret 2
What’s this all about?
• China has reverted to what it knows best – engineering a credit boom to support investment.
• It will likely delay China’s hard-landing.
• But only temporarily. China has been getting less growth bang for its credit buck since the crisis.
• It doesn’t change our fundamental view of China’s economy – it remains beset by major problems including over-capacity in key sectors and hidden non-performing loans in the banking sector. The proverbial can is being kicked down the road.
• It’s a short-term positive for the global economy. It might make 2016 “okay, but not great” rather than deteriorate further. But it won’t be enough to throw lower for longer off track.
• China’s medium-term financial stability risks have increased. And the UK is financially exposed.
Information classification: Public/Internal/Confidential/Secret 3
• China has engineered yet another credit boom to arrest the sharp drop in growth.
• New financing into the economy in Q1 was the strongest on record.
• If all that financing was an economy on its own it would be the world’s 16th biggest, not far off the size of Mexico.
• While we previously stated that policy making was not calibrated to the economy’s needs it has now shifted even further away from what is desired.
• The proverbial can is being kicked down the road.
0200400600800
1,0001,2001,4001,600
China Q1 New Financing v Economy Ranking($ Bn) China - Q1 2016 New Financing
Source: Bloomberg , IMF
1. China has reverted to what it knows best
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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - New Financing(Yuan Bn)
Source: Bloomberg
Information classification: Public/Internal/Confidential/Secret 4
• China is locked into a credit-intensive form of growth.
• The credit binge is being supported by fiscal expansion - the planned fiscal deficit for 2016 will be the biggest in at least 34 years.
• China on the face of it has plenty of room for fiscal expansion. Public debt is merely 30% of GDP.
• But that excludes local government debt. It could be as well over twice the 30% figure.
• And the government will likely have to pay for a significant banking sector bailout in the coming years.
2. It’s the third distinctive credit wave since the crisis, and it’s supported by fiscal expansion
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2 China - Fiscal Balance(% of GDP)
Source: IMF, China NPC
2016 Targetannounced at NPC
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500
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2002
2003
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China - Monthly New Financing(Yuan Bn)
Source: Bloomberg
1. Post-CrisisResponse
2. The post-crisis response credit
pick-me-up
3. 2016 Boom
Information classification: Public/Internal/Confidential/Secret 5
• The renewed credit deluge seems to have arrested the decline in growth.
• After slowing significantly in 2015, much more than the headline figures suggest, China’s growth may have bottomed, temporarily at least.
• Real estate and infrastructure investment growth rates have risen into Q1.
• Even steel seems to be on the up.
• The usual build-up of steel inventories over the winter was much less than usual. And it’s already being drawn down.
3. It seems to have got traction
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30 China - Fixed Asset Investment(% Y/Y Change)
Real EstateInfrastructureManufacturing
Source: Bloomberg
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(CNY)
Source: Bloomberg
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2012 2013 2014 2015 2016
China - Winter Steel Inventory Build
(Rebar)
Source: Bloomberg
Information classification: Public/Internal/Confidential/Secret 6
• The authorities have engineered yet another house price boom.
• Easier credit and a reduction in the required deposits for first-home buyers (from 25 to 20%) and second home buyers (from 40 to 30%) have helped.
• House prices in the largest cities (Shanghai, Beijing, Shenzhen, Guangzhou) rose a staggering 30%y/y in March.
• But the market remains afflicted by oversupply.
• China’s house prices are prone to wild swings. The next downturn is unlikely to be too far away.
4. House prices are on the rise but…..
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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
China House Prices(Newly Built, % Y/Y Change)
Tier 1 Cities Tier 2 Cities Tier 3 Cities Source: Bloomberg
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House Prices (All Cities - % Y/Y Change) - LHS
Residential Floor Space for Sale (10,000sqm) - RHSSource: Bloomberg
Information classification: Public/Internal/Confidential/Secret 7
• China’s post-crisis credit waves have been getting less growth bang for their buck.
• More and more capital is needed to produce an extra unit of output.
• The return on capital has been declining steadily since the crisis, as it has across emerging markets as a whole.
• So there are doubts about how long this latest growth fillip will last.
• It could fizzle out before the end of the year.
5. Less growth bang for its credit buck
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China - Incremental Capital Output Ratio
Source: OECD
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2001 2003 2005 2007 2009 2011 2013 2015
MSCI China - Return on Capital(%)
Source: Bloomberg
Information classification: Public/Internal/Confidential/Secret 8
The economy remains beset by:
• an excessive reliance on investment to drive growth
• a structurally low share of GDP going to household incomes
• over-capacity in key sectors
• hidden non-performing loans in the banking sector
• ad-hoc, reactive policy-making that fails to address the underlying distortions in the economy – the transition to a less debt-addicted, less investment-driven growth model remains some way off
6. It doesn’t change our view on China
Information classification: Public/Internal/Confidential/Secret 9
• China’s rapid debt build-up has been matched by sharp rise in the cost of servicing that debt.
• It is widely agreed that China’s banks are sitting on non-performing loans well in excess of official figures. But estimating the true size of the problem is very difficult.
• Our own estimate is the NPL ratio is around 25%. In the most pessimistic scenario NPLs are closer to 35%.
• We maintain the view that China won’t experience an out and out crisis.
7. A more painful day of reckoning awaits
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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
China - Debt to GDP and Debt Servicing (%)
Household and Corporate Debt as % of GDP - LHSDebt Servicing as Share of GDP (%) - RHS Source: BIS, Bloomberg
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Reported Optimistic Central Pessimistic
China - Estimating Banking Sector NPL Ratio (%)
Source: IMF, Penn World Tables, Bloomberg, Macrobond, RBS Economics
Information classification: Public/Internal/Confidential/Secret
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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Financial Exposure to Ch & HK ($ Bn)
World UK
Source: Macrobond 10
But the consequences of its credit boom will be far from painless. In the coming years we think China will experience:
• a balance-sheet recession (the debt hangover) as debt-burdened corporates prioritise debt minimisation;
• an impaired (eventually) banking system, constraining the reallocation of credit and productivity growth;
• a hangover of misallocated labour from the financial boom, also constraining productivity growth;
• an inadequate reform effort.
Our ‘not a blow-up, but many difficult years’ view on China remains.
8. China’s challenging future
The risk from financial exposures
• It’s too early to tell whether global financial exposures to China have increased in recent months in tandem with the credit boom.
• But even if it hasn’t, the latest credit deluge increases medium-term financial stability risks in China.
• The UK’s exposure to China is a concern.
Information classification: Public/Internal/Confidential/Secret 11
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