Outlook on the Chinese Economy. LI Xunlei October, 2015

Transcription

1 Outlook on the Chinese Economy LI Xunlei October, 2015

2 Summary 1. Chinese Economic Development and Outlook 2. Timetable for Economic Reform in China 3. How Can Economic Transformation Be Achieved in China? 4. Analysis of Recent Market Volatility 2

3 The Chinese Economy Comes to A Turning Point Today, the Chinese economy is characterized by 3 transitions, i.e. slowing economic growth, growing pain caused by economic restructuring and challenges in terms of digesting the previous fiscal stimulus. The aging population and a dwindling working population in China forced economic growth to slow down; the massive industrialization drive a few years ago is still troubling the Chinese economy with overcapacity and excessive leverage; after the demographic dividend disappeared marking the imminent end of the Late Industrialization period, there s still a long way to go for China to complete restructuring its economy. China s economy is undergoing 3 critical transitions Changing gear in economic growth The 3 transitions facing the Chinese economy Economic restructuring Digestion of the impact of the previous fiscal stimulus package 3

4 An End to the Economic Slowdown Still Not in Sight China s economic growth continued to slow down for 7 years since 2007, and the GDP growth has slipped from the peak of 14% to ~7%. Retrospectively, China had seen 2 continuous economic slowdowns in the past, i.e and that lasted 7 and 8 years, respectively. The 3 rd economic slowdown, as we re experiencing today, has thus far lasted for roughly the same length of time. As for the trough in growth rate, China s economic growth bottomed at 3.8% in 1990 during the 1 st slowdown, and at 7.6% in 1999 during the 2 nd decline. In 2014, GDP growth dropped to a similar level (i.e. 7.3%), but it s still hard to tell when economic growth will bottom out in China. Annual GDP growth in China (%) 18 中国 Actual GDP GDP 实际增速 growth rate in China 16 7Y 7 年下滑 slowdown 14 8Y 8 年下滑 slowdown 7Y 7 年下滑 slowdown

5 Industrial Production: Demand Declines across Downstream Sectors as China Enters the Late Industrialization Phase Among the factors contributing to the slowing economic growth, demand in all downstream segments led by real estate and automotive declined across the board. Property sales, in particular, posted negative growth for the second time, resulting in continuously shrinking industrial growth in businesses such as steel and cement. A decline in the growth of all industrial commodities indicates that the Chinese economy has entered the Late Industrialization phase. Commercial property and auto sales growth (%) Steel and cement production growth (%) 商品房销量增速 Property sales Auto 汽车产量增速 sales growth growth Steel 钢材产量增速 output Cement 水泥增速 output growth growth

6 Consumption: Traditional Consumption Lost Ground giving rise to New Consumer Spending Patterns With the arrival of Late Industrialization Phase, traditional consumer goods (i.e. food, clothing and household equipment and services) only account for a dwindling proportion of the total consumer spending of Chinese people, while the proportion of new consumer items (transport and communication, education and entertainment and healthcare), representing the current trends towards innovation and an aging population, has continued to increase. Food accounts for ~1/3 of total consumer spending in China. In 2013, urban Chinese consumers spent 34% of their total spending on new consumer products, higher than that of non-food consumer goods; in rural areas, new consumer goods take up 29% of the total spending, which is also close to that of non-food traditional consumer goods. Breakdown of urban and rural consumer spending per capita in 2013 (%) Food 食品 Clothing 衣着 Household 家庭设备用品 appliances Living 居住医疗保健 Healthcare 交通通信教育文化娱乐其他 Other Traditional consumption 传统消费 & goods 新兴消费 New consumer products Transport & communication Traditional 传统消费 Education & entertainment 新兴消费 New consumer consumption products 城镇居民人均消费支出结构 Structure of urban consumer spending per capita 农村居民人均消费支出结构 Structure of rural consumer spending per capita 6

7 Foreign Trade: Limited Room for Further Export Growth China currently accounts for over 12% of total global exports. Therefore, its share of global exports is unlikely to increase further, indicating that the devaluation of Chinese yuan will only boost Chinese exports to a rather limited extent. Since its entry into the WTO in 2002 until 2014, there s been a 6.2-fold increase in Chinese exports, and its share of global exports rose from 5% to 12.4%, or 1/8. As a result, the room for further growth is relatively limited, and the overall global economic downturn places extra pressure on Chinese exporters. Chinese exports as a percentage of total global exports Chinese exports as % of global 全球出口总额 Global exports (US$ ( 万亿美元 trn) ) Chinese 中国出口总额 exports ((US$ 万亿美元 trn) ) total 中国出口占全球之比 (right) (%, 右轴 )

8 Potential Growth to Slow Down But Stay above 6.5% in the Next 5 Years Assuming that China will follow a similar trajectory of economic growth as Germany, Japan and South Korea, China s economic growth will then decelerate at a certain point in the future. According to projections made by economists LIU Shijin et al., CAI Fang and GUO Yumei et al., China s GDP growth will likely slow down in the next 5 years and remain above 6.5%, which is also the minimum requirement to meet the target of doubling 2010 s GDP by 2020 set by the 18th CPC National Congress Projections of China s potential GDP growth (%) 中国潜在经济增速 (%, 蔡昉,2015) 中国潜在经济增速 (%, 郭豫媚等,2015) China s 中国 GDP 增速 growth (%) (%) China s potential economic growth (%, CAI Fang, 2015) China s potential economic growth (%, GUO Yumei et al. 2015)

9 Summary 1. Chinese Economic Development and Outlook 2. Timetable for Economic Reform in China 3. How Can Economic Transformation Be Achieved in China? 4. Analysis of Recent Market Volatility 9

10 Why Are the Current SOE Reforms Different? The ongoing SOE reforms are launched against a general background of the New Normal of the Chinese economy. As the reforms entered the deep water area, 3 long-term solutions have been proposed: (1) regulatory reforms focusing on category-based multilevel regulation, the bottom line is that, while ensuring leadership by the party, SOEs will be divided into non-profit, special-purpose and competitionoriented enterprises for which different reform approaches will be adopted, and relevant regulation will be conducted on all 3 levels, i.e. State-owned Assets Supervision and Administration Commission (SASAC), state capital management companies and for-profit SOEs; (2) property ownership the bottom line is to prevent any losses of state-owned assets, and the mixed ownership reform will be prioritized as the central issue, where securitization and state-owned assets, introduction of strategic investors and private investors, and employee stock ownership and stock incentive schemes will be implemented as the key measures; (3) business operation SOEs need to improve their business performance, scale up operations and consolidate their competitiveness by establishing a modern enterprise system. Latest 本轮 SOE 国企改革 reforms SOE reforms implemented on 3 levels Regulation 监管层面 Property ownership 产权层面 Category-based 分类监管 regulation Multilevel regulation 分层监管 混合所有制 Mixed ownership Business operation 经营层面 Modern enterprise 现代企业制度 system 10

11 Guiding Opinions Issued for SOE Reform with Well-Defined Principles and Objectives On 13 September, the CPC Central Committee and the State Council distributed the Guiding Opinions to Deepen State-Owned Enterprise Reforms and set forth the 5 fundamental principles for SOE reforms. Objectives of the reforms are to achieve decisive results in key areas and key operations concerning the SOE reforms by 2020, and establish a state-owned asset management system, a modern enterprise system and market-oriented management mechanisms catering to China s basic economic system and the socialist market economy, thereby further rationalizing the structure of state-owned assets in China. Specific targets include: by 2020, the corporate reform of SOEs will be preliminarily completed; the stateowned asset regulation system will be further developed; the efficiency of state-owned capital allocation will be significantly improved; and party leadership building will be fully strengthened among SOEs. Fundamental principles and specific objectives for SOE reforms 基本原则 改革目标 (2020 年 ) Fundamental principles Objectives (by 2020) Must adhere to and keep developing the basic 必须坚持和完善基本经济制度 economic system 坚持社会主义市场经济改革方向 the general direction 坚持增强活力和强化监管相结合 坚持党对国有企业的领导 regulation Ensure the party s leadership over SOEs 坚持积极稳妥统筹推进 Uphold socialist market economic reforms as Combine efforts to revitalize the economy and Active, steady and centralized reform promotion Corporate reform of SOEs will be preliminarily 国有企业公司制改革基本完成 completed 国有资产监管制度更加成熟 further developed 国有资本配置效率显著提高 企业党的建设全面加强 more efficient State-owned asset regulation system will be State capital allocation will be significantly Party leadership building will be fully strengthened among SOEs 11

12 Category-Based Regulation: SOE Category Simplification and Holistic Listing of SOEs It is expressly stated in the Reform Decision of the 3 rd plenary session that SOE reforms will be conducted and managed based on re-categorization of the SOEs. The Guiding Opinions divide SOEs into commercial and non-profit enterprises, of which the latter category is further divided into 2 sub-categories, i.e. SOEs within fully competitive industries and sectors, and SOEs within important industries and key sectors related to national security and the economic lifeline of the country, which are designated to undertake key special projects. We considers the differentiation between commercial and non-profit SOEs to be a highlight of the Guiding Opinions, as it allows reforms of the 2 types of SOEs to be implemented following different directions. In particular, state capital may be reduced to the level of general shareholders, rather than controlling shareholders, in the case of commercial SOEs specializing in competitive businesses. Category-based SOE reforms and performance appraisal Commercial SOEs within 竞争行业和领域的商业类 competitive industries and 国有企业 sectors 改革方式 Reform : approach: 实行公司制股份 Equity 制改革 diversification, 股权多元化 through, 着力推进整体上市 corporate reforms of SOEs, focusing on holistic listing of the SOEs 考核方式 Appraisal: : 重点考核经营业 Performance 绩指标 国有资产保值增值 appraisal mainly focuses on 指标和市场竞争力 business performance metrics, performance in terms of preserving and increasing the value of state assets, and enterprise competitiveness SOEs 国家安全 国民经济命脉 within key industries and sectors related to national 的重要行业和关键领域 security and national economy, 承担重大专项任务的商业 designated to undertake key special 类国有企业 projects 改革方式 : 保持国有资本控股地位, 支持非国有资本参 equity of the SOEs for equity 股, 积极实行股权多元化 Reform approach: Non-state-owned capital is encouraged to invest in the diversification, while ensuring the status of state-owned capital as controlling shareholders 考核方式 Appraisal: : In 考核经营业绩指 addition to business 标 国有资产保值增值的同时 the, SOEs 加强对服务国家战略 performance in terms of 保障国家安全和国民经济运 facilitating national strategies, 行 发展前瞻性战略性产业 safeguarding state security and national economic development, 及完成特殊任务的考核 performance metrics and state asset value preservation and appreciation, fostering potential strategic industries, and fulfilling special tasks Non-profit 公益类国有企业 SOEs 改革方式 : 可以采取国有独资形式, 具备条件的可以推 possible, investor diversification 行投资主体多元化, 鼓励非国有企业参与经营 Reform approach: The SOEs may be wholly state owned, and where may be implemented, encouraging non-state-owned investors to participate in SOE management 考核方式 : 重点考核成本控制 产品服务质量 运营效 mainly focuses on cost control, 率和保障能力 product and service, 考核中引入 quality, 社会评价 operational efficiency and Appraisal: Performance appraisal supporting capabilities, and public assessment should be incorporated into the appraisal framework 12

13 Multilevel Regulation: Shifting away From Enterprise Regulation toward Capital Management It is expressly stated in the Guiding Opinions that the authorization-based management system for state-owned capital should be reformed focusing on capital management, and state capital investment and operation companies will be restructured and established, indicating that SASAC has taken capital management as the clear direction for SOE reform. Such a shift ensures the leadership of the party as well as separating the government from enterprises to increase the operational autonomy of SOEs. We expect that SOEs will be regulated based on 3 levels, whereby SASAC will play a purely regulatory role in supervising state capital operators, who will also have limited exposure to business decision-making of invested SOEs instead, they will exercise their decision-making authority through the boards of shareholders, thereby allowing the boards of directors and the management of commercial SOEs greater power in business decision-making. Some provinces and municipalities introduced reform policies for competitive SOEs Province/ municipality Beijing Related policies By 2020, state capital should account for more than 60% of the total capital of urban public service and special-purpose SOEs Shanghai Tianjin Chongqing State capital will exit from some SOEs specializing in highly market-oriented and competitive businesses in an open, transparent and orderly fashion, through the introduction of a state capital movement platform In the case of competition-oriented SOEs, reforms will be gradually implemented to ensure a greater number of outside directors than inside directors, and efforts will be made to introduce the CFO assignment system All suitable SOEs and assets will be listed, and more than 80% of the state-owned capital of competitionoriented SOEs will be securitized Zhejiang Jiangxi No lower limit is set for state-owned equity in competition-oriented SOEs; manager recruitment of competition-oriented SOEs will be gradually opened up; the professional manager system will be adopted for competition-oriented SOEs on grade-2 or below; wholly state-owned provincial enterprises specializing in competitive businesses will set up the outside director system, and their boards of supervisors and supervision mechanisms will be further improved Efforts will be made to push forward the restructuring and listing of SOEs, especially competition-oriented SOEs 13

14 Multilevel Regulation: Temasek Model Is Worth Studying The Temasek model of Singapore merits particular attention. In the 1970s, Singapore had a large number of government-reliant state-owned enterprises, and Temasek was established to separate the government from the SOEs and to enhance their operating efficiency. As of March 2015, the average yearly return received by Temasek investors was 16%. Instead of directly participating in managing the invested SOEs, Temasek takes part in decision-making through voting in shareholders meetings. In addition, it is proposed in the Guiding Opinions that 30% of the proceeds of state-owned capital investments will be turned over to public finance by 2020 since SOEs enjoy preferential treatment of the state, the increase in SOE revenue turnover will fill the gap in social insurance, and a greater portion of SOE profits will be used to improve people s livelihood. Management architecture of Temasek Standing 常务委员会 Committee President 新加坡 of 总统 Singapore Ministry 新加坡 of Finance 财政部 任命 Appointment 淡马锡控股 Temasek s Board of 董事会 Directors 任命 Appointment Audit Committee 审核委员会 Leadership 领导力发展和 Development and 薪酬委员会 Compensation Committee Management of 淡马锡控股 Temasek 经理层 Holdings Board of 投资标的公司 Shareholders 1 的股东大会 Invested company 1 投资标的公司 Board of Shareholders 2 的股东大会 Invested company 2 投资标的公司 Board of Shareholders 3 的股东大会 Invested company 3 董事会和 Board & Management 管理层 Board & 董事会和 Management 管理层 董事会和 Board & Management 管理层 Board & 董事会和 Management 管理层 14

15 Pushing forward Mixed Ownership Reform As the solution to inherent issues associated with the domination by a single shareholder, the mixed ownership reform seeks to transform SOEs operating mechanisms by introducing non-state-owned investors to projects conforming to the state s industry development policies and conducive to industry upgrade, especially in businesses such as oil, natural gas, electricity, railroad, telecommunication, resource development and public utility. Currently, most listed SOEs are still controlled by the government, with a relatively low degree of mixed ownership. According to China s Ministry of Finance, among enterprises controlled or owned by state capital, 80% of the equity is held by the state; and the figure increases further to over 90% if wholly state-owned enterprises are factored in. Due to inefficient enterprise management resulting from the domination of a single shareholder, nearly 40% SOEs are operating at a loss. In 2014, the average ROE of Chinese SOEs was merely 5%, and that of local SOEs was even lower at 3.5%. SOEs are inefficiently managed, and 40% of them are loss-making Average SOE ROE continued to decline (%) Chinese SOEs: number of SOEs: loss-making SOEs 全国国有企业 : 户数 : 亏损企业 8 Chinese SOEs: number of SOEs: profit-making 全国国有企业 SOEs : 户数 : 盈利企业 ROE of Chinese SOEs ROE of local SOEs 全国国企 ROE 地方国企 ROE

16 Increasing the State Capital Securitization Rate Specific measures of the mixed ownership reform include: introduction of strategic investors, pushing forward SOE restructuring and listing, employee stock ownership schemes, attracting equity funds as shareholders, and introducing private capital to public projects. Securitization of stateowned capital will be an important means of implementing the reform. At the local level, a number of provinces have set out clear targets for asset securitization (50%+) in their SOE reform programs. As the leader in private economy development, Zhejiang aims to securitize ~75% of state-owned assets in 3-5 years, and Hunan and Chongqing set an even more ambitious target (state asset securitization rate of 80%). State capital securitization targets (%) set by some Chinese provinces and municipalities Hunan 湖南 (2020) (2020) Chongqing 重庆 (3-5 (3-5Y) 年 ) 浙江 Zhejiang (3-5 (3-5Y) 年 ) Jiangxi 江西 (2020) (2020) Henan 河南 (2020) (2020) Beijing 北京 (2020) (2020) Gansu 甘肃 (2020) (2020) Heilongjiang 黑龙江 湖北 Hubei (2020) (2020) (2020) (2020) Tianjin 天津 (2017) (2020) 16

17 Developing the Modern Enterprise System to Improve SOE Operating Efficiency The ultimate goal of SOE reforms is to enhance the management efficiency of SOEs. To this end, it is imperative to establish a modern enterprise system. Both the Politburo and SASAC issued several relevant policies since the introduction of the 4 reform pilots in last July. It is explicitly stated in the Guiding Opinions that a modern enterprise system will be established focusing on the joint-stock corporate reform, corporate governance structure, leadership management, salary distribution, internal personnel employment, etc. Category-based SOE reform and performance appraisal 公司制股份制改革 : 大力推动国有企业改制上市, 创造条件实现集团公司整体上市 允许将部分国有资本转化为优先股, 在少数特定领域探索 introduce the special state share administration system in certain sectors 建立国家特殊管理股制度 Joint-stock corporate reform: Actively pushing forward SOE restructuring and listing, and facilitating holistic listing of group companies. Some state-owned capital will be allowed to be transferred to preferred shares, and explorations will be made to 法人治理结构 : 切实落实和维护董事会职权, 法无授权任何政府部门和机构不得干预 ; 加强董事会内部的制衡约束, 国有独资 全资公司的董事会和监事会均应有职工代表 and supervisors of wholly state-owned enterprises and enterprises solely founded by the state. Corporate governance structure: Effectively implementing and protecting the power of board of directors, and no government department may interfere with such power without proper legislative authorization; balances and checks within the board of directors should strengthened, and staff representatives should be included in the boards of directors 企业领导人员分类分层管理 : 根据不同企业类别和层级, 实行选任制 委任制 聘任制等不同选人用人制度, 董事会按照市场化方式选聘和 election/appointment and management, and more managers will be hired through market-based recruitment. 管理职业经理人, 且增加市场化选聘比例 Category-based multilevel SOE leadership management: Election, appointment, recruitment, etc. systems will be adopted for SOEs based on their category and level. The board of directors adopts a market-oriented approach to professional manager 薪酬分配制度改革 : 对领导人员实行与选任方式相匹配 与企业功能 functions of the SOEs and tied with work performance will be implemented among managers of SOEs 性质相适应 与经营业绩相挂钩的差异化薪酬分配办法 Salary distribution reform: Differential salary distribution measures matching the corresponding manager selection methods and 内部用人制度 : 建立分级分类的企业员工公开招聘制度, 企业各类管理人员能上能下 员工能进能出 Internal personnel employment: Open, category-based and multilevel SOE staff recruitment systems will be established to enable the demotion/promotion of relevant management personnel, and the recruitment and dismissal of SOE employees. 17

18 Market-Oriented Interest Rate Reform: Deposit-Interest to be Fully Opened up within 2015 During the 3 rd session of the 12 th National People s Congress held on 12 March 2015, PBoC Governor, ZHOU Xiaochuan, talked about the timetable for interest rate liberalization in China: the deposit interest rate cap will likely be lifted in In fact, ZHOU elaborated on measures to step up interest rate liberalization in the Reform Decision Guidebook released at the end of November 2013, where the short-term, short-to-medium-term and medium-to-long-term objectives for interest rate liberalization were specified. In addition, he stated during the National People s Congress and the Political Consultative Conference in 2015 and the 6 th China-US Strategic Dialogue in July 2014 that China should be able to complete interest liberalization in 2 years. And YI Gang, PBoC s Deputy Governor, was also quoted saying that relevant conditions have become increasingly ripe for interest rate liberalization. ZHOU Xiaochuan s remarks on interest liberalization Time Occasion Event Nov Reform Decision Guidebook Near-term objectives: Relevant efforts will be focused on the market-based self-discipline mechanism for interest rate pricing and independent pricing by financial institutions; ensuring effective lending base rate offering as the basis for credit product pricing; facilitating interbank deposit certificate issuance and trading, and increasing the applicability of market-based pricing to debt products of financial institutions. Short/medium-term objectives: Fostering a fully-developed market-based interest rate system, and developing the central bank interest rate regulation framework and the interest transmission mechanism. Mid-term objectives: Interest rates will be fully liberalized, and the market-oriented macro-level interest rate regulation mechanism will be further developed. Mar NPC and the Political Consultative Conference The cap on deposit interest rate will be lifted, which should also be the final step toward interest rate liberalization. Since restrictions on many other interest rates have been lifted, deposit interest rates will also be opened up. I personally believe that this will be realized in 1-2 years. Jul th China-US Strategic Dialogue The goal is still to complete interest rate liberalization within 2 years, but the time for interest rate liberalization is also dictated by external factors, and the PBoC has its own timetable. Mar rd Session of the 12 th NPC Lifting the deposit rate cap is highly likely in

19 SDR, RMB Internationalization and Capital Account Liberalization Inclusion of Renminbi into the SDR basket of currencies has major strategic implications for RMB internationalization. First, it means that the RMB has become a global currency and an official currency used by IMF s member states, which will raise its position among currencies worldwide. Second, inclusion of the RMB into the SDR will boost global demand for Chinese yuan and therefore improve its functions as an international currency in terms of international payment settlement, financial transactions and official reserves. Lastly, given China s ~US$ 4trn foreign exchange reserves, we will be able to cut reserves once the RMB becomes a reserve currency, and the resultant saving of funds can be used for development purposes. Here, the SDR is discussed within the general framework of RMB internationalization. Viewed from a higher level, RMB internationalization, freely floating exchange rates, interest rate liberalization and RMB convertibility under capital accounts are 4 separate measures with a common goal, each serving as a necessary and sufficient condition for the others. The 4 in 1 reform incorporates separate but closely connected components RMB internationalization RMB convertibility under capital accounts Freely floating exchange rates Interest rate liberalization 19

20 Progressive Opening of RMB Capital Accounts The RMB capital account reform was significantly expedited in During the IMF annual conference in April, Governor ZHOU Xiaochuan disclosed that China plans to make the RMB freer to use ; in the RMB Internationalization Report (2015) released in June, the PBoC pointed out that we are not far away from RMB convertibility under capital accounts. Relevant policies have also been rolled out: bond repurchase was opened up for some overseas financial institutions; Mainland-HK fund mutual recognition was launched; and QDII2 and Shenzhen-HK Stock Connect are both on the horizon. Looking back at the capital reform history in China, relevant reforms have been steadily pushed forward despite temporary delays and drawbacks. The history of capital account convertibility reforms in China Reforms 97 年亚洲金 were put on hold due to the 融危机, 进 Asian financial crisis 程被搁置 in 1997 Making RMB a convertible 1993 年十四届三中全会 currency was proposed for the first 首次提出要 time in the 逐步使人 3 rd Plenary Session 民币成为可兑换的货币 of the 14 th NPC in 1993 The 2003 target 年十六届三中 of capital account 全正式重新提出 convertibility was officially re-proposed 逐步实现资本项 in the 3 目可兑换 rd Plenary Session of 的目标 the 16 th NPC in 2003 Delays in the reforms 2008 年全球 due to the global financial 金融危机 downturn, in 进程被延缓 2008 Cross-border RMB 2009 trade 年 settlement 2011 RQFII 年 Shanghai-HK 2014 年 pilots 启动跨境人民币贸 launched in launched 开展 RQFII in Stock 沪港通成 Connect 易结算业务试点 2009 制度 2011 launched 功开展 in 2014 Current accounts 1996 年经常项 2002 QFII 年 became fully introduced 目完全可兑换引入 QFII in convertible in 实现制度 QDII 2006 introduced 年 : 2003~2008 年 : 2010: 2010 年 2013: 年 : 年 in 引入 2006 QDII FDI FDI and 和 ODI 很大 Capital 将资本项目 account Announcement 十八届三中 of 债券回购交易 Opening of bond 制度 made 程度上实现了人 RMB convertibility 可兑换目标 was the 3 全会宣布将 rd Plenary 向已获准进入 repo to offshore significantly more 民币可自由兑换 included 写入十二五 in the Session of the convertible 寻找机会推银行间债券市 RMB clearing 12 对贸易融资以及 th Five-Year 规划 18 th NPC to seek banks and Registrationbased 与贸易相关的对 Foreign Plan 进 人民币场的境外人民 opportunities to participating 境外机构进 promote 资本账户可 free 币清算行和境 banks qualified for administration 非居民债权采用 organizations 入境内银行 conversion 自由兑换的 of 外参加行开放 interbank bond adopted 注册制 for trade were 间债市 allowed to RMB 进程 capital 两地基金互认 investment financing and enter China s accounts 上海自贸区 启动 Mainland-HK trade-related nonresident claims market Trade Zone recognition interbank bond Shanghai 成立 Free- fund mutual established launched 20

21 Capital Account Convertibility Enhanced Rapidly and Can Be Further Improved (1) Credit facilities commercial credit is already fully convertible in China according to relevant IMF assessment reports. (2) Direct investment China has opened up outbound direct investment (ODI), but direct investments in China by overseas investors and clearing transactions are still subject to government approval. Capital, money and derivative markets conversion of RMB is mainly realized through QFII, QDII and RQFII, where the investment quotas have been consistently increased. As of 29 June 2015, the investment quota for QFII reached US$ 75.5bn, QDII quota was close to US$ 90bn and RQFII quota was RMB 390.9bn, marking a 216-fold, 9-fold and 37-fold increase, respectively. Investment quotas for QFII, QDII and RQFII Total assets of QFII and securities held by QFII as a percentage of total assets 1, QFII investment 投资额度 ( quota 亿美元 (US$, 左轴 100mn, ) left) QDII 投资额度 investment ( quota 亿美元 (US$, 左轴 100mn, ) left) RQFII 投资额度 investment ( quota 亿元 (RMB, 右轴 100mn, ) right) 4,500 4,000 3, , , , , , Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun QFII Total 总资产 assets ( of 亿元 QFII,(RMB 左轴 100mn, ) left) QFII Securities 证券资产占总资产比例 held by QFII as % of (%, total 右轴 assets ) (right)

22 Exchange Rate Deregulation & Independent Interest Rate Policy Based on Mundell s ternary paradox theory, the PBoC had to choose 2 of the 3 options, i.e. free movement of capital, fixed exchange rate and independent monetary policy. The PBoC recently cut interest rates and reduced the deposit reserve ratio requirement (RRR). In our opinion, the RRR cut came as a surprise. The aim is to make it clear to the market that the PBoC gives greater emphasis to an independent monetary policy, and hence the previous reform of the exchange rate formation mechanism. In the past, China exercised control over capital flow. This, coupled with relatively fixed exchange rates, dictated that Chinese interest rates followed the trends in the US. However, the latest exchange rate reform made the exchange rate of RMB more flexible. In addition, capital movement control has been tightened up, and it is theoretically viable to pursue a totally independent monetary policy at the same time. Alternative monetary policies available to China under the Mundell Triangle Interest rates pegged to the US Independent interest rate policy Fixed exchange rate Capital flow Managed floating exchange rate Capital flow management 22

23 Summary 1. Chinese Economic Development and Outlook 2. Timetable for Economic Reform in China 3. How Can Economic Transformation Be Achieved in China? 4. Analysis of Recent Market Volatility 23

24 Solution: Growth Model Transformation Finding New Growth Drivers for China s Future Germany, Japan and South Korea all experienced a drop in national industrialization rate in their struggle to escape the middle income trap. Today, China has come to the Late Industrialization stage. According to the growth theory, transformation of the economic growth model is an inevitable outcome after growth driven by demographic dividend comes to an end. In other words, new growth drivers must be developed for the Chinese economy. We think our hope will mainly come from 3 factors: human capital represented by China s ample supplies of university graduates and engineers, the US model driven by innovation, and reforms promoted by President XI Jinping. Past Transformation of China s growth model Future Demographic dividend Human capital Investment Economic growth Innovation Foreign trade Reform 24

25 Growth of Human Capital Resulting from Increased University Enrollment The increasing popularity of higher education has been significantly improving the quality of labor force in China. Nearly 7 million students graduate from Chinese universities every year, as opposed to 1 million 10 years ago. From the perspective of non-agriculture employment, ~5 million new jobs will be created every year in the future, meaning that almost all the new jobs will be taken by university graduates. Therefore, it is imperative for us to develop a new economic growth model matching the characteristics of human capital supply in China. 9,000,000 8,000,000 7,000,000 6,000,000 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 0 No. of Chinese university and high school graduates by year 每年高等教育毕业生数量每年高中毕业生人数 No. of higher education graduates No. of high school graduates ,000 2,500 2,000 1,500 1, No. of new university graduates and new non-agricultural jobs (10,000) 新增大学生毕业数 No. of new non-agricultural jobs 新增非农就业人数 No. of university graduates

26 From Bank Financing to the Capital Market Why future enterprises will be nurtured on the capital market? An important reason is that return on capital will be trending down over the long term given China s ageing population. Therefore, there must be a shift away from expensive bank financing toward direct financing at a lower cost. Due to the large number of bank outlets and employees, bank loans are inherently cost ineffective. By contrast, the information sharing feature of direct financing enables enterprises to make substantial savings of financing cost, making it especially suitable at a time of low return on capital. Changes in financing structure Growth driven by demographic dividend High interest rates Bank financing High financing cost due to the large number of employees and business outlets Population ageing Low interest rates Capital market Low financing cost due to information sharing Source: Haitong Securities Research 26

27 Rise of the Service Industry amid Industrial Transformation Declining return on capital will lead to a shift in the financing system from banks to the capital market, and the resultant rise in labor cost will damage the competitiveness of Chinese industries against an increase in demand for services. As a result, the focus of China s economic structure will move from industries toward services. For traditional industries, there are only 3 solutions: (1) internationalization seeking new demand overseas through the One Belt and One Road platform; (2) entering the high-end manufacturing market by building their competitiveness; (3) establishing themselves as industry leaders through M&A. Changes in China s economic structure Going abroad through One Belt and One Road High interest rates Banks Industry Entering high-end manufacturing with improved competitiveness Becoming industry leaders through M&A Low interest rates Capital market Services 27

28 Reforms to Ensure Equity of Policies The 4 th Plenary Session decided that the establishment of a legal system featuring equal rights, equal opportunities and fair rules will be expedited to safeguard the personal rights, property rights and fundamental political rights of Chinese citizens. We think this means that more equity assurance policies will be introduced after the meeting to ensure fair play in market competition, fair trading of elements and fair income distribution. Outlook for reforms after the 4 th Plenary Session Equal opportunities Fair play in competition Speed is of paramount importance Equality as the top priority Equal rights Fair trading of elements Fair rules Fair income distribution 28

29 Summary 1. Chinese Economic Development and Outlook 2. Timetable for Economic Reform in China 3. How Can Economic Transformation Be Achieved in China? 4. Analysis of Recent Market Volatility 29

30 Internal Cause: Investor Structural Imbalance The total market cap of A shares now stands at RMB 43.1trn, the negotiable market cap totals RMB 34.9trn, and the free float market cap totals RMB 17.1trn, of which 46% is held by individual investors. Breakdown of free float market cap held by A share investors General corporate entities Funds Insurance & social insurance Individual investors PE Brokerages Large SOEs Other 30

31 Stock Markets Dominated by Individual Investors A shares have maintained a stable transaction distribution since 2007: individual investors account for 85%, institutional investors account for 12%, and corporate entities for 3%. Distribution of A share transactions Natural-person investors General corporate entities Professional organizations Source: Statistical Yearbook of the Shanghai Stock Exchange, WIND, Haitong Securities Research 31

32 Highly Speculative Markets The turnover rate among A share investors is far higher than investors in other stock markets. The turnover rate in China s GEM is 10x, whereas that of Nasdaq is only 2.5x. YTD turnover rates by market (annualized, %) 32

33 Internal Cause: Excessive Leveraging Prior to 15 June 2015, A share financing (margin trading + margin financing) / negotiable market cap reached 7.2%, matched only by the frenzied Taiwanese stock market in The slump in June was followed by investigations by the CSRC, and the A share leverage ratio is now lowered to a reasonable level around 3.3%. 12% 各国市场杠杆率比较 Stock market leverage by country 10% 615 调整前 Before 15 June, % 融资额 / 总市值最高值 Financing/total market cap Peak 8% 7.2% 融资额 / 总市值平均值 Financing/total market cap Average 6% Current leverage ratio 目前杠杆率 4% 2% 0% 3.3% 3.0% 2.30% 1.50% 0.9% 0.57% A 股杠杆 A share leverage ( 流通市值 ratio (negotiable ) Taiwan 台湾日本 Japan 美国 USA market cap) 33

34 Extreme Market Volatility A long-term bear market is caused by a reversal in fundamentals. The recent A share slump is attributable to individual events and institutional factors. Similar excessive corrections have occurred in overseas stock markets. Mid-term bull market corrections by stock market A shares (2015): Shanghai Composite Index A shares (2015): CHINEXT Index A shares (1996): Shanghai Composite Index Taiwan (1988): Weighted index USA (1987): S&P

35 Market Reconstruction in 3 Steps Interest rate Risk appetite Profit Inversion of order 10Y government bond yield (%, left) 1/A-share PE 10Y government bond yield (adjusted, %, left) YoY growth of A-share cumulative net profit (%, right) 35

36 Step 1: Stable Exchange Rate with Rate Cuts Confirmed Interest rate and RRR cuts by the PBoC on 25 August revealed the ternary paradox policy orientation. FOMC chose not to raise interest rates. RMB turnover in September dropped from US$ 25bn / day to US$ 15.1bn / day, indicating that the devaluation pressure on RMB has significantly subsided. 600 人民币成交金额 RMB turnover (US$ ( 亿美元 100mn) )

37 A Shares Became More Attractive After the Slump Lower interest rates led to changes in the asset price comparison effect, in favor of the stock markets. The current high dividend yield makes A shares substantially more attractive, similar to the level in March % 6.0% 5.0% 4.0% 3.0% 4.89% 主要投资品种收益率对比 Yields on main investment products 3.93% 3.16% 6.00% 2.0% 1.66% 1.0% 1Y 银行理财 bank wealth management 1 年期 1Y AA AA 企业债 corporate 货币基金利率 Money Avg. 股息率前 valuation 15 1 年期 bonds funds rate of 公司均值 top-15 companies by dividend yield A Overall 股整体股息 A-share 率 dividend ( 分红公 yield (dividend-paying 司 ) companies) 37

38 Step 2: Risk Appetite Correction Since July 2014, reforms have accelerated, gradually bolstering investors risk appetite. The most sensitive funds started to enter the market. Account asset growth YoY by category Under RMB 500,000 RMB 500,000 5mn RMB 5mn 100mn Over RMB 100mn Rate cut led to a lower risk-free rate Acceleration in reforms raised risk appetite Earnings expectations improved steadily Strong support Catalyst Safeguard After the promulgation of the top-level national reform plan, the supporting 1+N is expected to follow soon. Acceleration of reforms will help ease the pessimistic sentiment. 38

39 Growth Stabilization through Active Fiscal Policy to Allay Concerns over Deflation With the introduction of growth stabilization measures in July 2013, GDP growth in H2 will exceed the market consensus. The Ministry of Finance released the Fiscal Policy Measures to Support Economic Growth Stabilization on 8 September. GDP: cumulative YoY (%) Avg. GDP (E): cumulative YoY (%) 39

40 Step 3: Confidence Restoration after Successful Economic Transformation After WWII, representative stock indexes overseas increased times due to strong economic growth. The 13 th Five-Year Plan due for release during the 5 th Plenary Session of the 18 th National People s Congress in October will focus on economic restructuring and emerging industries. Implementation of relevant policies will rebuild investors confidence about China s economic transformation and innovation. Increases in related indexes (X) USA: USA: Japan: Japan: Taiwan: HK:

41 China in the Midst of Economic Transformation Economic growth models worldwide are shifting toward technological innovation as the growth driver, with the US taking the lead. The Chinese market is genetically suitable for internet development, and the Chinese government has introduced industry policies to support innovation. Investment of Chinese venture funds (VC + PE + Angel Investors) Number of A-share IPO Listed Companies since 2012 No. of investment projects (right) Total investment (RMB 100mn, left) SME 102, 25% GEM 176, 44% Main board 126, 31% 41