The near-term outlook for Chinese growth is set to improve as the potential dangers of another credit boom are ignored, argues Mary Nicola.

With China’s economy having last year grown at its slowest pace in a quarter of a century, the authorities’ task of shoring up activity has assumed a new urgency. The government is acutely aware that a protracted slowdown could spark social unrest.

In this context, it is not surprising that growth appears to have replaced economic and structural reform as policymakers’ key objective. The National People’s Congress (NPC) recently vowed to stabilise growth this year at between 6.5 and 7.0 per cent. We believe they will ultimately succeed in this goal.

Credit expansion and increased capital spending are likely to be a key area of focus. That is because in recent times both have typically been the only reliable means of generating growth quickly.

But it is worrying that the approach seems to be to counter the effects of past credit accumulation through even more credit accumulation.

The problem is that China’s total debt to GDP ratio was already at 247 per cent at the end of 2015. Corporate debt alone stood at 165 per cent and has been rising rapidly which is worrying, particularly given overcapacity in sectors such as steel, coal and cement. The government’s renewed focus on growth via investment means that these industries will not be required to make the necessary restructuring, and the danger is that the authorities are going to face an even bigger problem further down the road.

There are obvious concerns that by postponing dealing with the overcapacity issues facing these industries China is putting short-term interests ahead of the reforms that are crucial to its long-term health.

Focus on growth

The expectation had been that key reforms including the privatisation of state-owned enterprises, improvements in corporate governance, the shoring-up of local government finances and opening up the country to greater foreign investment, would boost productivity growth. That has failed to happen to the extent many China market watchers hoped for.

Various measures announced during the NPC suggest the authorities are determined to prevent growth from falling below 6.5 per cent this year. These include a modest rise in the budget deficit target and allowing local governments to boost spending by issuing up to 400bn yuan of debt.

These measures point to a renewed focus on capital spending – the dominant driver of growth over the last decade as contributions from labour, and especially productivity, have stagnated.

Meanwhile, ambitious targets for M2 growth, a broad measure of China’s money supply, and, for the first time, total social financing (TSF), suggest that credit growth will probably be an important tool as well.

Countering structural slowdown a policy priority

Source: Macrobond, March 2016
5yma - five-year moving average; IP - industrial production

Credit easing is back on the agenda

The People’s Bank of China (PBoC) surprised markets in February as it eased policy further with a 50 basis point cut in the reserve requirement ratio. Money supply growth has shot up in recent months, reflecting the aggressive policy easing seen by PBoC over the last year or so.

The pace of monetary easing has accelerated (% change)

Source: Macrobond, March 2016
3mma - three-month moving average


China’s broadest measure of new credit surged to a record in January. A seasonal lending binge pushed TSF up to 3.42 trillion yuan in January, compared with a median forecast of 2.2 trillion.

An increase in bond issuance by both companies and local governments is likely to keep credit growth high, supporting consumption. Household spending should also be helped by the recovery in house prices seen since the start of the year.

PBoC playing down threat of devaluation

In addition to credit expansion, market watchers will keep a close eye on where foreign exchange policy fits into China’s plans to stimulate growth. PBoC Governor Zhou Xiaochuan has repeatedly tried to play down fears that a major weakening of the currency is imminent, telling reporters at a press briefing in March that China will look to boost exports through a “competitive devaluation”.

Some market participants are unconvinced by the rhetoric, and see a large one-off devaluation as a distinct possibility. But we believe the central bank will resist such pressure. With China’s equity markets having endured a bumpy ride over the past year – as at 5 May the Shanghai Composite Index was down over 40 per cent since reaching an all-time high in June 2015 – policymakers will be reluctant to do anything drastic that may spark further sell-offs in Chinese assets. On that basis, we believe a period of stability for the domestic currency is more likely.

While we previously expected a real trade-weighted yuan depreciation of between three and five per cent over the next 12 months, we now feel the horizon over which this happens has probably lengthened. In the near term, the central bank will probably look to keep the yuan stable.

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