how can china respond to global market turmoil
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8/3/2019 How Can China Respond to Global Market Turmoil
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How Can China Respond to Global
Market Turmoil?With the markets in turmoil due to escalating worries about the global economic
outlook, many investors have been questioning what policy measures China
might be expected to implement in the event of a double dip recession in the US
and/or Europe. During the global downturn of 2008-9, China stood out as the
bright spot among major economies, contributing to over 50% of global growth in
2009 as spending on stimulus-related infrastructure projects got underway. We
do not think there is a high likelihood of another large-scale fiscal stimulus in the
event that external conditions deteriorate, considering that:
China has managed to maintain recent growth despite a negative
contribution from net-exports
Policymakers are focusing on containing the risks associated with local
government debt and an imbalanced property market (both issues that
were aggravated by the last stimulus campaign). A second large
stimulus program would exacerbate these risks and intensify the
economic imbalances that the government is trying to curb during the
12th
Five-year plan
There is some leeway for monetary easing when inflation has peaked,
particularly if the outlook for imported inflation is milder.
In the event of another global downturn, the government may support
households through more aggressive pro-consumption measures, and consider
improving the allocation of capital to the more efficient private sector. We would
also expect a higher degree of central government support to ensure adequate
funding for existing investment projects, especially in relation to affordable
housing.
China is relying less on exports for growth, but more is needed to boost
consumption
Chinese economic growth has become less reliant on net exports in recent
years, while the proportion of exports destined for the US and the Eurozone has
been declining (see Figure 1).
In 1H11, China’s economy maintained a reasonably strong pace of expansion
(9.6% YoY), even with net exports detracting 0.43 percentage points and 0.1
percentage points from headline growth in 1Q11 and 2Q11, respectively, as
compared to having contributed an 18.1% share to GDP growth in 2007 (see
Figure 2). The contribution to growth from consumption picked up from 36.8% in
2010 to 47.5% in 1H11, while the contribution from gross capital formation was
53.2% in 1H11 (vs. 54% in 2010). If China’s policymakers want to further shield
the country’s growth outlook from external shocks (without relying on elevatedfixed asset investments), more measures will be needed to boost domestic
consumption.
HANDS-ON CHINA REPORT
August 10, 2011
Jing Ulrich
Chairman, Global Markets, China
+852 2800 8635
Amir Hoosain
+852 2800 8641
Kelvin Wong
+852 2800 8962
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Jing Ulrich HANDS-ON CHINA REPORT – August 10, 2011
10%
12%
14%
16%
18%
20%
22%
24%
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
2 0 1 0
2 0 1 2
Figure 1: Chinese Exports by Destination
US
EU
EM
Source: CEIC
With China’s fiscal maneuverability somewhat constrained, the more constructive approach to solving
some of the current issues is to accelerate domestic reforms that aim to stimulate consumption. Many
pro-consumption initiatives have already been introduced, including a massive undertaking toincrease the availability of affordable housing, healthcare reforms to make basic services and drugs
more accessible, as well as an increase of the personal income tax threshold. These and other
initiatives will reduce precautionary savings in the medium- to long-term and liberate a greater portion
of disposable income. A more aggressive solution to unlock consumer spending would be to resume
the process of interest rate reform. Strict controls over interest rates have pushed real savings growth
into negative territory. This has forced the average citizen to seek out alternative (riskier) means to
preserve wealth, which in turn discourages spending, since personal net worth has become more
volatile. In a recent discussion, Nicholas Lardy of the Peterson Institute for International Economics
highlighted the 8% growth of household savings during the period from 2004 to 2010, reaching ~37%
of disposable income at a time when real interest rates were on average -0.3%.
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Jing Ulrich HANDS-ON CHINA REPORT – August 10, 2011
-7
-2
3
8
13
18
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1H11 2H11
Final Co nsump tio n Gross Capital Formatio n Net Exp orts
Figure 2: China’s GDP by Expenditure, percentage points
Source: CEIC
Division of central and local government fiscal responsibilities
Much of the investment projects that featured in China’s 2008 stimulus package had been planned for
some time, but were fast-tracked as a response to the external downturn. Existing fiscal policy
initiatives are already stimulative - according to the 12th Five-year plan, China will invest as much as
RMB7 trillion into the construction of urban public facilities in the next five years. With rising risks of an
external recession, the central government would probably focus on ensuring sufficient financing for
existing investment projects before contemplating a second major stimulus package.
There is a clear need in China for a redistribution of fiscal revenues and expenditures. Over 50% of
fiscal revenues are currently concentrated at the central level, however the expenditures of the central
government, account for only 20% of nationwide public spending (compared to 30% in Japan and
60% in other major economies). The funding issues associated with the affordable housing initiative
highlights the mismatch between a centrally-issued directive (requiring local governments to lease outland without charge and source the necessary funding) and the difficulty for local governments to
complete targets. On July 15, it was reported by the China Securities Journal that Chen Yuan,
Chairman of China Development Bank, gave an estimate of RMB500 billion for the size of the funding
gap with respect to this year’s affordable housing construction target of 10 million units. China’s
banking regulator has urged banks to extend credit at preferential rates to aid the construction of
affordable housing, while the NDRC said in June that local governments could issue bonds to fund
public housing construction.
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Jing Ulrich HANDS-ON CHINA REPORT – August 10, 2011
48.9%47.8% 47.6%
45.0% 45.4% 45.1%
47.7% 47.2%45.9%
46.7%47.6%
48.9%
68.5%
65.3%
69.5% 69.3% 69.9%
72.3%74.1%
75.3%77.0%
78.7%80.0%
82.2%
30%
40%
50%
60%
70%
80%
90%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Figure 3: Local governments’ share of revenues & expenditures
Share of Revenue
Share of Expenditure
Source: J.P. Morgan research by Samuel Chen
The current fiscal system gave rise to the recent episode of elevated borrowing by local government
financing vehicles (LGFV). Particularly in the last year, a lack of clarity on the health and magnitude of
LGFVs has raised concerns. Since 2002, local government-related debt has risen substantially from
about 12% of GDP to 27% of GDP by the end of 2010, or RMB10.7 trillion. The chief worry is that a
future increase in non-performing loans (NPLs) could hinder growth. Reports have cited varying levels
of high-risk loans, from a few percent to over a quarter of the total LGFV loan base. However, we are
not overly alarmed in this regard. According to J.P. Morgan’s China banks analyst Samuel Chen, most
of LGFV debt was spent on basic public infrastructure, transportation, and energy sectors, which
generate cash flow and forms a good asset base that can be sold if necessary. Also, based on debt-
to-GDP or debt-to-current fiscal strength ratios, debt affordability is still not stretched. Sam Chen
believes that the need for bailouts is unlikely, especially given that pre-emptive measures have
already been adopted by regulators in the past 18 months. More specifically, he argues that the local
government debt issue will not pose a systemic risk, given that:
1. There are sufficient fiscal revenues to enable the central government to prevent such a crisis,
and they likely will.
2. Owing to closed capital accounts, there will not be a trigger for an uncontrollable liquiditycrunch.
3. Strong fiscal revenue growth is expected in the next few years, which will boost debt
affordability. In particular, budget revenue (ex. land sales) may increase by 20% CAGR in the
next five years.
4. Over 70% of LGFV debt is used in transportation, infrastructure, and energy sectors, which
forms a good asset base that can be sold if necessary.
Going forward, it is highly unlikely for any one local government to default, as the central government
has implicit claim and responsibility on assets and liabilities held by subordinate governments.
However, local governments would still benefit from some degree of reform in the tax system that
would bring fiscal revenues and expenditures more in line.
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Jing Ulrich HANDS-ON CHINA REPORT – August 10, 2011
More efficient allocation of capital
At the corporate level, capital has historically been allocated inefficiently with an imbalance in accessto credit – i.e., large SOEs have the clout to obtain more favorable interest rates and terms, whereas
private companies (and especially SMEs, which account for 60% of GDP) lack the bargaining power
to access cheaper bank credit and have increasingly relied on alternative lending channels to meet
their frequent borrowing needs. There are signs that government efforts to optimize the loan structure
are having some effect. According to the PBoC, outstanding loans to small and medium enterprises in
2010 stood at RMB17.68 trillion, greater than outstanding loans to large enterprises of RMB13.42
trillion. Moreover, growth of loans to large enterprises was 13.3% during the year, compared to 29.3%
and 17.8% recorded by small and medium-sized enterprises respectively. The government has also
differentiated reserve requirements for Rural Credit Cooperatives and announced trial plans to allow
SMEs to issue bonds in private placements.
Some leeway for monetary easing
The 87% expansion in China’s M2 money supply since January 2008 has given rise to very stubborn
inflation, which has been exacerbated by food supply disruptions and rising commodity prices. As the
government is concerned that inflation could undermine social stability, we do not think that
policymakers will be inclined to unleash another torrent of credit, although there will be greater leeway
to ease policy once inflation is seen to be under control. With the aggressive hikes of reserve
requirement ratios, some RMB16 trillion of banks’ deposit base is still frozen (see Figure 4). A weaker
global economy should also translate into lower commodity prices, which would reduce (imported)
inflationary pressure. With CPI inflation likely to have reached a cyclical peak at 6.5% in July, J.P.
Morgan economist Grace Ng’s baseline scenario is that China’s central bank will likely take a pause
from further interest rate moves during 2H11.
4
6
8
10
12
14
16
18
20
22
24
Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
Figure 4: Reserve requirement ratio (%)
Large banks
Small & mediumbanks
19.5%
21.5%
2005
Source: CEIC
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Jing Ulrich HANDS-ON CHINA REPORT – August 10, 2011
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