China’s economy “weakens,” “stalls,” or “is struggling.” Looking at the world’s second-largest economy, pessimism prevailed most recently. We spoke with Bill Maldonado, head investment strategist Asia-Pacific at HSBC Global Asset Management, who says that the trade conflict with the U.S. is not contributing to China’s economy slow-down.
AsiaFundManagers.com: Many financial market participants blame the trade conflict with the US for the weakness of Chinese equities. You are not. Why so?
Bill Maldonado: Let’s look at the last few years. At 6.8 percent, growth in China was very strong in 2017. In 2016 it was 6.7 percent. By comparison, 2018 therefore saw only a relatively slight slowdown. The strong growth in 2017 was used by political decision-makers to tighten regulations for the stock market or for so-called shadow banks. This has slowed the economy slightly but made it more robust for the future. The global economic slowdown has certainly decelerated the Chinese economy even further. However, there is very little evidence that trade tensions have contributed to the slowdown.
“Problems in China different from those often mentioned”
In my opinion, the problems in China are different from those often mentioned in the market. One of the most fundamental problems is that the state plays too big a role in the economy. Moreover, despite its size, the Chinese economy is financed by a handful of state-controlled banks. To solve this problem, Chinese capital markets need to open further.
AsiaFundManagers.com: Predicted falling growth rates in China are one part of the problem. 6.0 or 6.5 percent – how reliable are the Chinese government’s figures?
Bill Maldonado: China has a large and complex economy and is undergoing a structural transition. There has been limited data capturing the new economy and services sectors. A study done by St. Louis Fed in 2017 says: “We found that the Chinese National Bureau of Statistics has improved its source data and its collection practices. This is making final official statistics higher quality than those of many counterparts in the developing world.” However, “even if every Chinese economic number were reported truthfully and accurately to the best of an individual’s understanding, the official numbers would still fail to fully capture the evolution of an economy growing and changing so quickly.”
Most studies done by academia suggest that the Chinese official economic data is still a good indicator for the overall direction of the economy. Even though the absolute levels or growth rates are still subject to debate. In particular, we think the custom trade, inflation and credit data tend to be more reliable. As a result, while tracking the official data, we also look at data from other sources such as industry associations and company reports. At the global level, we apply a “big data” approach to track where China (and other major economies) are in the business cycle.
Reforms needed to improve Chinese economy
AsiaFundManagers.com: The Chinese government wants to implement reforms, cut back the shadow banking system, reduce debt and at the same time stimulate growth. How can this work?
Bill Maldonado: Several supply-side reforms have been highlighted, among others, as key focuses to address the debt/financial instability risks. This includes the SOE (State-owned enterprises) reform on the basis of “competitive neutrality” to level the playing field for private enterprises and foreign investors. Financial reforms also include the interest rate reform to improve credit risk pricing and monetary policy transmission, promote the financial sector competition, and facilitate more efficient credit/capital allocation. More reforms include fiscal/local government debt reforms, to improve the transparency and sustainability of local government debt. This is achieved via increasing the share of bond issuance in local government financing and reducing the share of off-balance sheet financing channels such as shadow banking borrowings.
“Overall non-financial sector debt to GDP ratio higher in 2019”
To balance the need to control financial stability/debt risks and support stable economic growth and employment, there has been a pause in deleveraging, relaxation of shadow banking regulations (e.g. the bank WMP and the AMP rules), and looser control on local government implicit debt. We expect the overall non-financial sector debt to GDP ratio to edge higher in 2019. 2017-18 saw corporate debt-to-GDP ratio edging lower though household and government debt continued to rise. The focus now is to improve the quality and transparency as well as productivity of new credit and fiscal resources. Specifically, the government wants to increase credit supply from the formal/regular banking sector and capital market financing while containing shadow banking activities.
In addition, many measures have been rolled out to help improve banks’ capacity and willingness to lend. For example, targeted cuts in Reserve Requirement Ratio (RRR) and other liquidity injection to lower banks’ funding costs and encourage their lending to private enterprises and small and medium enterprises (SMEs). Other measures targeted bond issuance by private enterprises and equity financing e.g. the Science-Technology Innovation Board – China’s Nasdaq strategic to help (high tech & innovative) “new” companies’ equity funding.
The continuation of local government debt swap programme coupled with the government’s pledge for continued liquidity support to these local government financing vehicles (LGFVs) that fund major infrastructure projects has reduced the default risk of bonds issued by these LGFVs. The government has also asked financial institutions to work with local governments to resolve the LGFV legacy issues, etc. capital market liberalization and benchmark index inclusion of Chinese bonds and equities could also attract funding from foreign institutional investors.
AsiaFundManagers.com: Which leeway does the People’s Bank of China (PBoC) have to set growth impulses?
Bill Maldonado: The room appears limited for the PBoC to implement aggressive monetary stimulus, given elevated debt, lower interest rates, a weaker current account balance and large fiscal deficits. Further large liquidity injection could see diminishing marginal benefit and raise the risk of money flowing to asset market speculation.
“Still room for PBoC to increase credit impulse to economy”
However, there is still plenty of room for the PBoC to increase credit impulse to economy via improving policy transmission and efficiency of credit/capital allocation toward more profitable and productive private enterprises. There has been a shift in PBoC policy focus from driving down risk free rates to lowering risk premium for private enterprises and SMEs. By targeting at the private sector and SMEs, instead of highly leveraged SOEs and property sector as in the past easing cycles, China could potentially achieve more broad-based and sustainable recovery as well as lower credit-intensity of growth.
AsiaFundManagers.com: How will the recently passed package of measures – a reduction in the tax burden, relief for private companies – affect the Chinese economy?
Bill Maldonado: The government plans tax and fee cuts – including social security contributions – amounting to about CNY 2trn or about 2% of GDP for 2019. This combined with some tax cuts announced (total of about CNY 1.3trn and 1.4% of GDP) and took effect last year should help corporate earnings and cash flow and household disposable income. In particular, the VAT cuts, effective from 1 April, do not only benefit the corporate sector but help private consumption as the corporate tax savings are likely to be partially passed on to retail prices. These together with improved financing support for private enterprises/SMEs should buoy business sentiment and help stabilize the employment outlook. Indeed, recently we have seen green shoots in the economy with policy effects gradually coming through.
It could potentially take longer time for countercyclical policies focusing on the private sectors and tax cuts to spur private sector spending. The policy transmission is also less uncertain and more difficult to estimate as the fiscal/policy multipliers tend to be lower. Companies may use the tax savings to pay off existing debt or keep the money for precautious savings, rather than spending it especially on capex. However, the recent rebound in business sentiment bodes well for a positive feedback loop to form in the near term. Policies focusing on consumption and SMEs could also reduce the import intensity of the cyclical recovery and the potential impact on the trade balance, especially as there are recently emerging signs of a modest export recovery.
AsiaFundManagers.com: Thank you very much for the interview.