China remains on course to supplant the US as the world’s largest economy and is steadily liberalising its financial markets. While the pace of growth, which as recently as 2012 hit an annual rate of 12%, has slowed to around 6.7% the country remains the envy of most others and the ‘one belt one road’ (OBOR) vision for China’s future unveiled in 2013 promises to attract significant foreign investment.
The country’s major strengths were highlighted recently at the second China Capital Markets European Conference, held in London by the Asia Securities Industry and Financial Markets Association (ASIFMA) and the Association for Financial Markets in Europe (AFME), which also noted the bouts of volatility over the past year. They include last August’s mini-devaluation of the renminbi (RMB) and sharp falls on the Shanghai stock exchange since its June 2015 peak.
More positive developments have been the inclusion of the RMB from this October into the special drawing rights (SDRs), a reserve asset managed by the International Monetary Fund (IMF) and the opening up earlier this year of China’s domestic interbank bond market (CIBM), following a relatively low-key announcement by the People’s Bank of China (PBOC) that it was changing the rules.
Global recognition of China’s economic reforms encourage the authorities to continue in their policy of liberalising the financial markets and the exchange rate, said Chi Lo, senior economist, Greater China, for BNP Paribas Investment Partners. “The outlook is for a bigger, stronger China integrating onto the world stage.”
In recent months, the PBOC had attempted to rebuild confidence by maintaining a fairly stable exchange rate for the RMB so that it becomes a more ‘normal’ currency. However, Lo believes that the PBOC is “still on a learning curve” as it adjusts to the demand by international investors for full transparency and predictability if they are to support China’s capital markets.
Investors are also uncertain about the aims of the OBOR initiative-more recently shortened to ‘belt and road’ (BAR) – does Beijing have a step-by-step plan or is it merely an undefined vision? The lack of specific launch dates for projects and little evidence of coordination currently indicate the latter, said Lo. Moreover, China is assuming further credit risk in some neighbouring countries that are part of BAR, with no certainty that the plans will go through smoothly.
In the meantime, macroeconomic indicators suggest that the rebalancing of China’s economy – by reducing its reliance of investment and exports through a greater shift to domestic growth – got underway in 2013-14, so the country is three years into a process likely to run for a decade or longer.
Michael Taylor, managing director and chief credit officer of Moody’s Investor Service Hong Kong, said that China’s authorities face a “tri-lemma” in attempting to achieve three specific objectives: maintaining annual gross domestic product (GDP) growth at 6.5%-plus; reforming and rebalancing the economy to more domestic growth (BAR outlines no less than 330 measures) and – although not articulated in any policy document – the aim of maintaining stability, including social stability.
There had been a credit-fuelled surge in investment by China’s state-owned enterprises (SOEs), but this wasn’t matched by the private sector and the authorities recognised that the level of SOE investment was unsustainable. At the same time, they were unwilling to allow economic growth to slow down further and would probably have to abandon efforts to meet all three goals.
Yet although Taylor believes that China’s economy is undergoing through a challenging period, he doesn’t anticipate it experiencing a ‘Minsky moment’- the term for a sudden major collapse of asset values, which is part of the credit cycle or business cycle and follows a long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money. He sees such a scenario as unlikely as the state remains very actively involved in China’s financial system, with banking and portfolio transactions still tightly controlled.
A portrait of the current state of China’s economy was offered by Mark Austen, chief executive officer (CEO) of ASIFMA. He began by referencing China’s debt to GDP ratio, which at 232% is already very high for a developing country and could exceed 300% by 2020. Of that current total, 126% is contributed by the corporate sector.
China’s total of 232% is well ahead of another major emerging market, India, whose figure is 137%. It also exceeds that of Thailand (165%), Taiwan (137%), the Philippines (88%) and Indonesia (66%).
The country’s problem or non-performing loan (NPL) ratio is a matter of some conjecture. China’s banking regulator officially reports that they represent no more than 5.5% of total commercial lending; an International Monetary Report (IMF) issued in April suggested that 15.5% was a more realistic figure, amounting to US$1.3 trillion.
A recent poll conducted by Standard Chartered asked respondent what they believed were the biggest economic challenges facing China’s economy, with 28.4% citing the curbing of capital outflows and stabilising the RMB, while 26.1% said it was stabilising GDP growth at 6.5%-plus. This figure has been the ‘floor’ officially established by president Xi Jinping for the rest of this decade, but some claim that actual growth is already below the reported current figure of 6.7% and could be only 4.5% or even lower. Add to this the current rate of capital flowing out of the country, with over US$600bn leaving China last year.
However, Austen said that these alarming figures are offset by a number of more positive features:
• Although China’s reserves have slipped from US$4 trillion in 2014, the current total is still substantial at US$3.2 trillion, while the RMB has stabilised and will have a weighting of 10.92% in the IMF’s benchmark SDR currency basket when it joins on October 1 – placing it behind the US dollar (41.73%) and euro (30.93%) but ahead of the yen (8.33%) and the pound (8.09%).
• The opening up of the CIBM, which will allow foreigners to invest directly in what is, at US$7.4 trillion, the world’s third-largest bond market.
• China’s urban population represents only 54% of its total population, compared with a figure of over 80% for developed countries. This means that the trend towards greater urbanisation is ongoing and requires significant investment in infrastructure.
• China’s services sector enjoyed 8.3% growth last year and now represents more than half of the total economy. New and dynamic companies such as ‘China’s Google’ Baidu, e-commerce giant Alibaba and internet service portal Tencent (the trio collectively known as BAT) have joined the China’s top 15 companies by market capitalisation and are major investors.
• China is midway through its restructuring away from an investment-led economy over-reliant on exports to one that is more consumer-driven and service oriented – and to date has managed the process fairly successfully.
Austen’s conclusion: “We don’t foresee a financial crisis happening in China in 2017 or 2018; however we could see some major problems developing in the next three to five years if the country’s economic problems aren’t addressed promptly.”
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