China continues to focus on growth not reform

Given the traumatic experience with the large fiscal stimulus in 2008-09, the NPC will need to be cautious about the announcement and the implementation of any stimulus.

The key concern for those against additional stimulus in China is that it will only feed overcapacity in state-owned enterprises. This is why I expect a strong warning in the NPC statement that the stimulus will exclude “zombie companies”, loss-making state-owned firms that use up lots of resources.

The elephant in the NPC meeting room: excess capacity

 After a series of official spokesmen confirmed that the central government is determined to tackle overcapacity, it is clear that the NPC will need to make reference to this issue.

It may even announce concrete measures, such as restructuring of zombie companies in sectors which have more capacity than is needed, including steel, cement, coal, flat panel glass, paper making and shipbuilding.

There are rumours that funds of at least 150 billion yuan, equivalent to $23 billion, will be earmarked to help corporates lay off 5 to 6 million workers and retrain them within 3 years.

Given the amount of excess capacity in China, and the fact that fiscal and monetary policy will be more lax than they are even now, it is difficult to believe that the above strategy will solve the problem. The incentives to accumulate additional overcapacity will still be there.

This is why the search for external demand is still very important for China’s leadership. This – beyond more political and strategic considerations – explains Xi Jinping’s strong push for the Belt and Road mega-initiative. We, thus expect the NPC to announce a series of policies to facilitate investment projects along the Belt and Road, thereby, dumping excess capacity on neighbouring economies.

Domestically, one more way to reduce excess capacity would be a boost in urbanisation. During the October Party Plenum it was announced that some 100 million Chinese people would be urbanised in the next five years, and we expect this to be repeated or even strengthened. It goes without saying that such a process will increase demand for urban infrastructure, which relates to the sectors with excess capacity.

In the same vein, there is a push to use fiscal means to subsidize house buying plans, which, together with faster urbanisation, should help support China’s housing market, particularly in the second tier cities.

It seems that the leadership’s fear that China’s housing market may have become too large for the size of the economy has abated, and that maintaining high growth has become the one and only target.

Fiscal expansion

 The People’s Bank of China (PBoC) has estimated that fiscal spending could go up to RMB 2.9 trillion this year (from RMB 1.6 trillion in 2015), an increase of over 80%, equivalent to 4% of 2016 GDP.

Based on the PBoC’s own assumptions, such fiscal policy could continue for the next 10 years, which would raise debt from 53% in 2015 to 70% in 2025 (based again on PBoC’s own numbers). The Chinese government probably feels they have room to do this, as such a debt level is low compared to the developed world, where there are levels of over 90% of government debt to GDP.

Monetary expansion

 The PBoC is back and ready to do its upmost to support economic growth. Aware that such massive open market operations as those conducted since late January cannot be maintained to inject liquidity, the PBoC cut banks’ reserve requirement rate (RRR) last Monday. This opens the door to more lax monetary policy in a more structural way.

In this context, the market rumour that a 2016 consumer price index (CPI) target of 3% will be announced at the NPC meeting hints at a much more lax monetary policy in the future, under the mantra that the PBoC is pre-emptively reducing deflationary pressures.

We expect at least two more RRR cuts this year. On top of that, the NPC may also announce a very lax M2 money supply growth target for 2016 (13%), even when compared with their nominal growth target (9.5% if the rumours of a 3% inflation target are confirmed).

As if this were not enough, the government is keen to receive liquidity from the rest of the world and to go back to net capital inflows instead of outflows. This has been behind the reduction of the PBoC’s balance sheet, notwithstanding the PBoC’s liquidity injections and, thereby, the expansion of net domestic assets in the PBoC’s balance sheet.

Many of the announcements to attract capital inflows have already happened. However it is likely that the NPC will dwell on them further, so that the opening of China’s bond and money market to foreign investors is perceived as a landmark in China’s opening up of the capital account.

 All in all, China’s leadership does not yet seem ready to change the course of action at their national gathering this weekend. It looks as if muddling through is going to be the preferred option as opposed to stepping up reform.

The key signal is that the growth target has not been lowered and that monetary and fiscal expansions have already been announced. The elephant in the room, the reform of state-owned enterprises to reduce excess capacity, will not be tackled fully.

But this is an increasing point of contention for investors, and the communiqué of the NPC meeting will have to mention dealing with zombie companies, as well as the availability of funds to restructure some of those corporations. This is welcome but it is clearly not enough. Therefore I, expect China to continue to focus on growth and not on reform overall.