China: NPC signals policy stability and continuity

Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers (AXA IM), reiterates policies will continue to be “steered” in a direction of long term stability after the National People’s Congress (NPC) meeting in China last week.

Premier Li Keqiang’s opening speech at the NPC struck a fine balance between delivering near-term growth and furthering structural reforms. In the year of leadership transition, the emphasis of the government’s Work Report, as expected, was placed on preserving macro stability and policy continuity. This means, in our view, that economic policies will not see major shifts and any changes are likely to be applied in moderation. This is particularly true with respect to the growth target, where despite the change in wording, we think the tolerance for growth dipping below 6.5% remains limited.

Also, the setting of cyclical policies appears to be more “timid” on the surface – with lower credit growth targets and steady fiscal deficit – but bearing in mind that the government can find many off-balance-sheet ways to fuel growth when there is a need. Finally, the announced reform agenda contained few surprises, as the focus was on policy continuity – on capacity reduction, State-Owned Enterprise (SOE) reforms, financial liberalisation – which all hints at the desire to minimise shocks. Overall, the “steady as she goes” economic plan points to some upside risks to our below-consensus growth call of 6.2%. However, with many unknowns (internally and externally) that could unsettle the outlook, we prefer to stay put with our forecast for the time being.

Key points:

• A lower growth target does not mean a policy shift. As anticipated, the government has lowered its 2017 growth target to “around 6.5%” from last year’s 6.5-7%. Even though the number, 6.5%, appears to have shifted from the bottom-line to the center, the government still has a skewed preference for stronger growth. Not only did Li hint that the government, in reality, should aim to achieve higher growth when possible, the target for job creation was also increased to 11 million, from 10 million last year. As we explained earlier, the twisting of the words (on the growth target) does not qualify for a policy shift away from pursuing near-term growth, but it reflects a more balanced view of it in relation to other policy objectives, such as deleveraging and supply-side reforms.
• Less emphasis on growth renders the need for more stimulus. With the desire shifting from “reviving growth” (in 2016) to “preserving growth” (this year), the need for more short-term stimulus has waned. On monetary policy, the “neutral and prudent” policy setting was confirmed by the lower M2 and Total Social Financing targets. Recent comments from the People’s Bank of China (PBoC) also suggest that the current policy setting is appropriate for the real economy, but the need for financial deleveraging may require further actions. The latter means further tightening in interbank market rates and shadow banking regulation cannot be ruled out.
• On the fiscal front, the government has kept the target deficit unchanged at 3%, but it will be incorrect to think that fiscal policy will deliver zero growth impulse. Not only can the government mobilise fiscal savings to beef up actual spending (last year’s realised deficit was 3.8% of GDP before accounting for these savings), the government can also deploy resources that are not captured by the budget (for example, the issuance of “revenue bonds” will double this year to RMB800bn). What is also worth noting is that the mix of fiscal outlay is gradually changing from spending-focused (particularly on infrastructure) to more tax/fee reductions. This is important because the latter can benefit the private sector more broadly, making it more effective in stimulating private demand and shifting resources away from the public sector.
• Continuing structural reforms, but at a measured pace. The plan on structural reforms treads a similar line to that of last year, highlighting the need to reduce overcapacity, deleverage the corporate sector and restructure SOEs. However, because of the focus on growth stability, the government has refrained from setting more ambitious targets. For example, the reduction in coal and steel capacity was lowered to 150 million and 50 million tons, compared to 290 million and 65 million cuts that actually took place last year. Given the success of capacity reduction in boosting commodity prices and the Producer Price Index (PPI), the lowering of the targets may also reflect a desire to control inflation.
• Closing low-quality capacity and shutting down “zombie” firms appears to have gained more significance, although scant details were released on the latter. Similarly on deleveraging, the government has released more guidance on debt-to-equity swaps and using asset-backed-securities to redistribute risk, but it fell short on providing specific targets and numbers. The all-important SOE reforms got a special mention, and the commitment to accelerate the process has made the A-share market excited this year. However, the strategy preferred by the government – i.e. making the SOEs larger and more efficient, without losing the state control – seems to be at odds with the market, which favors more privatisation and break ups. We think the government will stay on its own course and push the reform forward at a faster pace this year.
• Making the yuan more international and market-driven combined with more promotion of renminbi assets. The currency reform is among the most anticipated financial-market policies. In the Work Report, the government pledged to continue the reform to make the exchange rate “more market-determined” and to maintain the “stable status of the renminbi (RMB) in the international currency system”. The first part of sentence is easy to understand, indicating that the foreign exchange reform will not backtrack (as the new head of SAFE put it, once the reform window is open, there is no turning back). Regarding the second part, since the yuan has already become a reserve currency, reinforcing its global status means, in our view, that RMB assets need to be more widely held by foreign investors. Greater market accessibility and improved market infrastructure (e.g. allowing foreign investors to hedge currency risks) should help to push this process forward. To the extent that successful market liberalisation can attract more capital inflows, it will also help to balance the capital account and ease pressure on the RMB. We continue to see the CNY/USD trading at 7.1-7.3 by year-end, but with more balanced risks now than before.

-ENDS-