Cao Yuanzheng May, 2017

Transcription

1 Current Risks of China 's Economy Cao Yuanzheng May, 2017

2 The Structural Problems of China 's Economy The 22 indexes and 8 obligatory targets in the 11th Five-Year Plan have been met. Of the 14 anticipated targets, 11 targets have been completed. On the morning of March 5, 2011 when delivering the Report on the Work of the Government at the Fourth Session of the 11th National People's Congress, Premier Wen Jiabao pointed out that the proportion of the added value of t h e s e r v i c e i n d u s t r y, t h e service employment proportion and the share of budget for R&D in GDP haven't met the set target.

3 Directions for the China's Economy Structural Adjustment In the process of the 11th Five-Year Plan, the arising problems have highlighted the two characteristics of China's economic structure: 1. China's economic growth is still mainly driven by the manufacturing industry. The service sector is lagging behind. 2. China's industry is export-oriented with great dependence on external demand, and highly sensitive to world economy. expand domestic demand Both domestic and overseas demand should be e x p a n ded. The core of expanding domestic demand lies in expanding consumption, which could be achieved by increasing the income of residents. The key areas of economic restructuring put forward in the 12th Five- Year Plan develop services vigorously promote the balanced development of primary, secondary and tertiary industries with focus on the development of tertiary industry

4 Prominent Achievements of China's Economy Structural Adjustment Urban and Rural Residents Income Growth Rate Budget Share of the R&D in GDP nominal growth rate(%) disposable income growth rate of urban family disposable income growth rate of urban family Budget Share of R&D in GDP The 11the Five- Year Plan The 12the Five- Year Plan Source: Wind info and BOCI Group Source: Wind info and BOCI Group

5 Prominent Achievements of China's Economy Structural Adjustment (100 million) Added Value of Secondary and Tertiary Industry GDP Growth Rate of China's Provinces on year-on-year basis (%) Secondary Industry Tertiary Industry Source: Wind info and BOCI Group Source: Wind info and BOCI Group

6 Emerging Industries are Growing The initial success of China's economic restructuring indicate that new economic growth points are emerging. 01 The increase of the residents income, esp. the rural residents. Consumption shifts to service industry. The development of health, education, finance, elderly care, tourism and other industries are speeding up. 04 New economic growth points The consumption expansion of the communications equipment, furniture and decorating materials. 02 Meanwhile, in addition to the technological progress of the automobile and other traditional manufacturing industries, new competitive advantages of the high-speed rail, electricity transmission and other equipment manufacturing industry has taken shape. Central and West China have become the emerging areas of industrial development. 03 Macro regulation has fostered a favorable environment for these emerging industries.

7 The 13th Five-Year Plan Systems of various fields become more mature and institutionalized, which covers all aspects of social development, such as SOE reform, finance, fiscal and tax system, government actions and opening up. Further improve the environment quality, which includes increasing the exploitation and utilization rate of the energy resources, the gathering momentum of the green and low carbon way of life and work, the improvement of the functional zoning system and the mechanisms for compensating for ecological conservation efforts Maintain a medium-high rate of economic growth. Maintain a minimum economic growth rate of around 6.5%. Advance the urbanization rate. Increase the proportion of the service industry and residential consumption to achieve the industrial upgrading The Goal of the 13th Five- Year Plan 3 2 Increase people's living standard and quality. Realize relatively full employment. Improve the public service systems, such as employment,education,culture, social security,healthcare and housing. Markedly improve the nationals quality and social civilization. Public cultural systems will be basically built. Develop the culture industry into a pillar industry for the national economy.

8 The Medium-high Rate of Economic Growth and the Optimization of Economic Structure According to the target set in the 13th Five -Year Plan, China's GDP will double by 2020 compared with that of To meet this target, in the next five years the average GDP growth rate should reach at least about 6.5%. In addition to maintaining high-speed economic growth, the urbanization rate and service industry proportion as a share of GDP also need to increase. The Targeted Average GDP Growth Rate in the Next Five Years (100 million CNY) Contribution of Major Sectors to GDP Growth Left axis: constant-price GDP in 2010 Right axis: GDP growth rate Agriculture Secondary Industry Service Industry Source: Wind info and BOCI Group

9 The Medium-high Rate of Economic Growth and the Optimization of Economic Structure The 13th Five -Year Plan has underlined that in the process of economic transition, we should pay attention to industrial upgrading, regional collaborative development and energy conservation and environmental protection. Consumption is the foundation Consumption upgrading Increase consumption rate Develop cross-border e- commerce Investment is important Infrastructure investment, including urban underground corridors and information technology networks Introduce private capital through PPP Regional Integration The Beijing-Tianjin-Hebei integration The Yangtze Economic Belt Industrial Upgrading The Made in China 2025 initiative The Internet Plus action plan New Energy Reforms The reform of SOEs: modern corporate system and mixed ownership structures The reform of fiscal, tax and government budget systems. The reform of finance: improve the direct financial ratio, reduce financing costs Opening up FDI Deregulation and ODI expansion Gradually open the capital account The Belt and Road Initiative. Strengthen the regional cooperation and trade liberalization

10 The Transformation of China's Economy Given the current development trend of China's economy, in the aspect of demand structure, the consumption proportion in the GDP will be more than 50% by In the supply structure, the service sector will account for more than 55% of GDP. This means that China's economy will develop into a consumer-oriented service economy with long-term sustainable economic and social development. The 13th Five -Year Plan period will be the vital moment of this transformation. The so-called supply side structural reform is to establish and improve the new system to support this transformation in order to cultivate the new drivers of economic growth. In the real economy, China's imports, especially imports of service products will increase. China will shift from the opening up of the manufacturing industry to the service industry, of which building bilateral and multilateral free trade zone systems is the foundation, while the Shanghai Free Trade Zone development is the focus. China's financial market opening will accelerate. The core of The Belt and Road Initiative is inclusive development, which reflects the traditional Chinese philosophy of Harmony matters. This idea has underlined China's vision to build a free trade system. China's announcement of joining the TPP negotiations is a practical action to uphold the economic globalization.

11 The Leverage Changes of the China's Economic Sector Over the Past Decade The International Ratios of Leverage Released by the BIS Germany Emerging Markets Brazil Government Family Non-financial sector India Source: Wind info and BOCI Group South Africa Russia The overall leverage is low, but the risk of local government debt is increasing. Mexico Corporate leverage is higher than the international average, exacerbating the fragility of the financial system; In terms of the industry, the leverage of coal industry and most of the heavy industries are higher. In terms of the regions, in China's northeast, north, southwest and other heavy industrial areas, the leverage are relativley higher. Currently, China's debt risk is mainly concentrated in the local government and enterprises, where there is also the deleveraging pressure. Given that macro economy has almost bottomed out, financial risk prevention should be an important priority of 2017 economic policy, of which orderly deleveraging is the direction. The main approaches are: (1) adjust and optimize the leverage of the central government, local governments and enterprises. Increase the proportion of the central government and residents leverage appropriately. (2) multi-pronged approach to reduce corporate debt levels. Proportion in GDP(%) Non- Financial Sector Private Non- Financial Sector Famlily Non- Financial Enterprise Sector Governme nt Japan France Canada Developed Countries The United Kingdom China USA Austrialia All Countries in the BIS Report

12 China's high leverage risk has attracted international attention China's high leverage risk has attracted international attention in 2016, IMF and BIS published a report to discuss China's high leverage risk, but the calculation of debt ratio in the international organization is considered too general, especially the judgment method to determine the pressure of China's non-financial enterprises through the credit / GDP indicators is worthy of discussion. China s financial system takes the indirect financing as the principal thing, which will undoubtedly heighten the macro leverage of enterprises. The macro debt ratio can not be equated with the corporate solvency. The most appropriate debt level in theory and practice is not conclusive. Corporate debt levels are not the same in different countries and at different developmental stages. In spite of this, it is an indisputable fact that the pressure of debt repayment for China's non-financial enterprises is increasing. Debt ratio of Non - financial corporate sector:according to BIS statistics,the number rose from 79.3% in 2007 to 170.8% in 2015 Corporate solvency:china's industrial enterprises'profit had a year-on-year growth of 8.5% in 2016 which is significantly decreased compared to the average annual growth rate of 17% over the past decade. The appropriate level of debt in theory and practice is not conclusive. Corporate debt levels are not the same in different countries and at different developmental stages. China's debt risk is mainly concentrated in three aspects: the bank's bad assets; the shadow banking default; the sustainability of local government debt. Source: Wind info and BOCI Group

13 Noteworthy economic and financial risks (2) Positive financial challenges On the basis of the controllable financial and debt risk, the deficit level is raised on the foundation of 2016, and the adjustment of the deficit rate is continued. On the one hand, reducing the macro tax would promote the development of enterprises and reduce the financial revenue. On the other hand, the ensurance of people's livelihood would increase the financial expenditure. Only if public finance relies on other channels, we could set up the infrastructure investment with a certain scale. For the current local government, not only the fiscal revenue declines, but also there is a high pressure of debt repayment in some areas. The new deficit will be mainly used to compensate for the reduction and ensure the government's responsibility of expenditure. Infrastructure funds are very limited. Quasi fiscal means Special financial debt Government investment fund PPP project

14 Commercial banks' bad assets do not lead to the emergence of systemic financial risks Bank's bad debts have increased since 2013 Cushion: as long as it does not exceed the loan provision ratio. Currently, the provision coverage ratio of China's commercial banking sector is 176%, and the capital adequacy ratio is 13%. Mortgage loans accounts for the highest proportion Cushion:As long as the housing price does not fall below 30% commercial bank's provision coverage ratio(left axis) Source: Wind info and BOCI Group commercial bank's NPL ratio (right axis) property development loans (%) Source: Wind info and BOCI Group real estate individual housing development loans (%) loan (%)

15 Commercial banks' bad assets do not lead to the emergence of systemic financial risks Changes in non-performing loan balances Source: Wind info and BOCI Group QoQ of non-performing loan balance YoY of non-performing loan balance

16 Shadow Bank 's Supervision Shadow Bank 's Supervision The balance sheet incorporates nonstandard assets CBRC Balance of assets and liabilities Transparency of standard assets CSRC Principles of risk disclosure

17 Asset securitization is a new idea of shadow bank transparency Play the basic similarly functions of commercial banks. Including maturity transformation, credit conversion, liquidity transformation and so on Shadow bank (system) basic characteristic The core issue: not subject to regulation or only less regulated, poor degree of information disclosure. There is a higher risk. Funds are mainly from wholesale financing, a large number of over-the-counter transactions, opaque information, and a generally higher leverage ratio. The positive meaning of the shadow bank: financial disintermediation It began to securitization in the primary market, and has not formed a transaction in the secondary market.

18 The proportion of shadow banks in total social financing is increasingly shrinking ( billion CNY) New foreign currency loans Off-balance sheet financing Securities financing Source: Wind info and BOCI Group

19 The Characteristics of China 's Local Government Debt China's government debt, including local government debt, accounted for a lower level of GDP in the world with 44.4% in At the same time, China is unitary state, the central government bear the obligations of local finance. About half of the China's local government debt is local financing platform debt. The local government only bears the guarantee responsibility, and local financing platform enjoys some income in considerable projects, covering some repayment of debt. There is a severe vulnerability in China's local government debt Serious term mismatch. According to the audit report released by the National Audit Office in 2012, 48.85% of local government debt occurred after the 2008 global financial crisis. Deposits are short-term, but loans are long-term. Debt occurs mainly at the grassroot government. According to the audit report released by the National Audit Office in 2012, China 's 2179 county - level governments, only 54 are not in debt. Although the amount of debt is not large, but they have a numerous liabilities which increases the difficulty of debt management.

20 The basic idea of resolving local debt Strengthen fiscal discipline Financial and taxation system reform, redistinguish central and local authorities Separation of debt and fiscal revenue Local financing platforms operate as enterprises. Debts as corporate liabilities, not to be repaid with fiscal revenue. local government bond Real public finance debt Core The issue of extension, to have a debt restructuring in the period of extension, implement the PPP. Asset securitization, solve the issue of bank debt through the development of bond market.

21 RMB exchange rate and the rising risks of cross-border capital flows Economic fundamentals Financial factors Balance of payments Future uncertainty The US economic recovery process accelerated in the second half of 2016 China's economy is entering a new stage of speed shift The process of interest rate increase for Federal Reserve is started. Emerging markets generally arise the intensified capital outflows,and the new phenomenon of increasing pressure of exchange rate devaluation. Double surplus replaced by a narrowing current account surplus and a capital account deficit. The RMB exchange rate is more susceptible to volatile and variable crossborder capital flow The US dollar strengthens. The follow-up effect of Brexit

22 Currently, RMB depreciates against the U.S. dollar Exchange rate of U.S. dollar against the RMB Exchange rate of RMB against the U.S. dollar offshore and onshore exchange rate spreads(right axis) onshore exchange rate(left axis) offshore exchange rate(left axis) Source: Wind info and BOCI Group

23 While other currencies remained stable and increased slightly RMB exchange rate against major currencies USD exchange rate against major currencies The exchange rate of USD against RMB (left axis) The exchange rate of EUR against RMB (right axis) The exchange rate of 100 JPY against RMB (right axis) Source:Wind Info and BOCI Group USD index(weighted index to six main currencies) (left axis) The exchange rate of EUR against USD (right axis) The exchange rate of 100 JPY against USD (right axis) Source:Wind Info and BOCI Group

24 USD strengthens against other currencies USD index and RMB exchange rate index USD against RMB index RMB exchange rate index USD index(left axis) USD against RMB(right axis) CFETS RMB exchange rate index BIS RMB exchange rate index SDR RMB exchange rate index Source:Wind Info and BOCI Group Source:Wind Info and BOCI Group

25 MB has not yet seen significant devaluation signs in fundamentals The stability of a country s currency depends on labor productivity and determines purchasing power parity. In the long run, if a country's labor productivity continues to increase compared to other countries, the currency will show an appreciation trend (Balassa-Samuelson effect). China s labor productivity is improving slowly, which is estimated at 3% per year, due to the economic transformation and the development of the service industry. This not only determines the foundation of the RMB ROA, but also means that there is no longterm devaluation basis although the RMB cannot appreciate quickly. In the medium term, China currently does not form the cost-driven inflation of price trend although the economy deflation ended and the PPI gained a positive growth which pushed up the CPI correspondingly. The CPI of 2017 is expected to be around 2.5%. In other words, the RMB purchasing power is relatively stable which contributes to a stable one basket exchange rate. In the short term, the exchange rate fluctuations of the RMB against the USD mainly depend on the trend of the USD, especially the Fed's rate hike frequency and amplitude as well as its expectations on the USD.

26 The current reason for the volatility of the RMB exchange rate offshore RMB guides onshore RMB Offshore RMB exchange rate the exchange rate of USD against RMB 3-month premium or discount of offshore RMB exchange rate(right axis) Middle rate of RMB against USD(left axis) Source:Wind Info and BOCI Group overnight CNH HIBOR(left axis) offshore rate(right axis) Source:Wind Info and BOCI Group spot exchange rate(right axis)

27 The current reason for the volatility of the RMB exchange rate - the interest rate starts to guide the exchange rate U.S. treasury securities rate China treasury debt rate US: treasury yields: 2-year US: treasury yields: 10-year Yield to maturity of China treasury debt:10-year Yield to maturity of China treasury debt: 2-year Source:Wind Info and BOCI Group Source:Wind Info and BOCI Group

28 Currently the formation of RMB exchange rate needs two markets, three forces and multiple transmission Two markets Offshore market(cnh)and onshore market(cny) Three forces Institutional investors, residents and monetary authority(central bank) Transmission mechanism 1.When institutional investors of offshore market expect the RMB to depreciate, their reaction will immidiately affect onshore market, causing the spot exchange rate to change and return to offshore market. Measures taken by monetary authority(central bank) are to increase market interest rate and tighten RMB liquidity on the offshore market, such as limiting the net outflow of RMB to raise overnight interest rate and stabilize the exchange rate, and then the interest rate parity appears. 2.When the spot exchange rate of onshore market changes, residents see the spreads between foreign currency and local currency increase, with the absence of actual using of foreign currency, they will speculate more on foreign currencies to earn spreads like trading stocks, so the foreign currencies in their household balance sheets increase, but there is actually no physical outflow. At this point, the monetary authority can only sell foreign currencies to stabilize the market and prevent the speculation, and then exchange rate equalization appears.

29 Currently the formation of RMB exchange rate different acts to common point China's international balance of payments capital account and financial account have undergone new changes apart from those current account and capital account which use foreign currencies normally: on the one hand: foreign institutional investors driven by the zero-risk and high-return of RMB asset began to return to the mainland. In the second quarter and third quarter of 2016, the net inflow of securities investment was $ 7.7 billion and the net outflow was $ 10.5 billion, significantly down from the first quarter which has a net outflow of $ 40.9 billion. On the other hand, domestic residents are showing a keen interest in buying foreign currencies which demonstrates a net outflow of central bank s foreign currencies reserve(a decrease in the reserve), the net outflow was up to billion US dollars in November, However, different acts have a common point - the RMB asset return rate. Chinese residents purchasing of foreign currencies lead to a sharp increase in the Chinese bank residents foreign currencies deposits, but they did not remit abroad significantly in the expectation of exchanging USD to RMB when the RMB devaluate substantially. Different acts and common point indicate that interest rate parity is accelerating its formation. The RMB interest rate, especially the zero-risk and high-return RMB asset has become a new exchange rate control means to the monetary authority (central bank).

30 Future policy trends: speed up the reform of exchange rate formation mechanism In the short term, a previous guidance is the point for China s monetary authority. The USD overvaluation accounts directly for the volatility of RMB exchange rate currently and market predicts that Federal Reserve System may raise the interest rate 2-3 times in While strengthening the international macroeconomic coordination, the central bank will intensify its anticipated management of RMB trend, promoting the RMB closing price to be normal through the operation of foreign currency parity and deepened communication with the market. At the same time, according to the demand of residents for currency purchasing, the consideration for actual background of exchanging currencies will be consolidated by the central bank to restrict the speculation unless that is an actual using of currencies, the main measures are to control the channels of foreign currency outward remittance, such as a compliance review on residents buying a house abroad or investment of financial asset to avoid the self-realization of prediction on exchange rate fluctuation. In the medium term, the central bank will implement prudent monetary policy in 2017 with M2 expected to grow by 11.5%. At the same time, the deleveraging of non-financial enterprises will start substantially. All these will tighten the liquidity and raise the short-term interest rates, and the long-term steep yields will be affected correspondently. It objectively contributes to attracting capital inflows, thus helping stabilize the RMB exchange rate. In the long term, One Belt, One Road" as well as the RMB s participation to the SDR emphasize the RMB exchange rate parity. It is imperative to break the barriers between offshore and onshore markets, so as to achieve the conformity of domestic and international interest rates. China comprehensively opened the domestic inter-bank bond market to foreign institutions in 2016, allowing them to largely release Panda bond, Shenzhen and Hong Kong s no-limit on the total amount is an example. Currently the RMB interest rate is about 300 basis points higher than the USD interest rate, it s cost-effective to hold RMB assets as long as the exchange rate of USD appreciate against RMB is no more than 3%.

31 Comparison of Sino - US Spreads The deposit and lending rate in China The 10-year national debt spreads between the US and China 1-year deposit rate Source:Wind Info and BOCI Group 1-year lending rate China s 10-year national debt yields National debt rate and spreads between America and China America s 10-year national debt yields Source:Wind Info and BOCI Group

32 Prospects At present, the disparity of the economic cycle to each country determines the division of monetary policy, inducing the uncertainty of international short-term capital flows and intensifying the risk of financial unsteadiness which urgently needs all countries to strengthen their macroeconomic coordination, But it has become more and more difficult to adopt such policies when confronted with deglobalization. If not careful, it can not be ruled out the possibility of a new economic crisis like Asian financial crisis in 1998 when short-term capitals flock to America, increasing the imbalance of international balance of payments in countries that capitals flow abroad. If so, the RMB will be expected, as in 1998, not to devalue. On the one hand, it may lead to a dramatic increase in China s imports, pushing the country s enterprises to suffer more competitiveness and a weakened earnings prospect. On the other hand, the non-devaluation RMB will serve as a anchor currency to the exporting countries to China especially the Asian countries. Under this circumstances, RMB will be likely to give up keeping a close watch at USD exchange rate while correspondently links to One Basket currency, and then the RMB exchange rate is fully converted to a interest rate issue. From this perspective, it appears to be very essential that the yield rate curve which is represented by national debt yield rate be complete. An interest rate market of diversity and coherence with a reasonable term structure can be expected.

33 Thank you! Doctor Cao Yuanzheng Address:Fuxingmen Avenue 1,Beijing, Telephone: Fax: