MACRO REPORT China Economy Update March 2015 Key Insights Monica Defend Head of Global Asset Allocation Research Qinwei Wang Economist Global Asset Allocation Research Economic Conditions: China s macro data have been broadly weak at the start of the year. However, these data should be treated with extra caution, as they are distorted by a shift in the timing of the Chinese New Year. Downward pressures on economic momentum seem to have shifted from real estate towards local government spending, given tighter regulations in place. But fears of either a sharp slowdown of the economy or serious deflation risk are probably overdone. Policy Stance: The new policy strategy is becoming clearer while regulations are being tightened to restrict credit to wrong areas, policymakers are seeking ways to support the right parts of the economy. The central government will probably increase its own spending to offset weakness from more controlled local government financing. Meanwhile, the PBOC (People s Bank of China) seems to be relatively accommodative, and probably is prepared to use all available tools. In our view, these measures should help the economy achieve a soft landing, with reform implementations likely to accelerate. Currency: Recent downward pressures on the Renminbi (RMB) are largely the result of China s exporters shifting their views to a strong dollar, by reducing their dollar trade financing and increasing dollar cash. Any RMB adjustment is likely to be limited to a degree by China s still effective capital controls, the PBOC s more than sufficient forex (FX) reserves, and continued large current account surpluses. We don t expect any large swing in the Renminbi this year. China Macro Pulse CONDITIONS STABILITY CONDITIONS Poor Good Poor Good China is tightening regulations, particularly on local government out-ofbudget financing and activities. As a result, downward pressure on economic momentum is shifting to local govt spending from property. Policymakers are seeking ways to support right parts of the economy, offsetting downside risks. In particular, central government will probably increase its own spending, while the PBOC is also becoming more accommodative. China Internal rebalancing is already underway, although still in early stage. Fast household income growth supports consumption. Structural reform implementation is likely to accelerate, facilitating further structural adjustment. External balance remains resilient, which should help the PBOC keep renminbi and capital outflows under control. In fact, trade surpluses have picked up in recent months, supported by lower commodity prices. Source: Pioneer Investments. Data as of February, 27 2015. 1
$ Bn China Macro Report March 2015 Economic Conditions: Cloudy to Start 2015 Data for the start of 2015, including trade, inflation and PMIs (Purchasing Managers Index), were broadly weak. However, underlying economic conditions are probably not as bad as headline data first show, given distortions caused by a shift in timing of the Chinese New Year (CNY). The shift in timing of the Chinese New Year is distorting macro views at the beginning of 2015. January s sharp fall in exports could be largely explained by the calendar change. Last year, CNY was at 31 st Jan., and many firms rushed to ship their s overseas ahead of the long holiday. This year CNY was on 19 th Feb., resulting in a stronger base for comparison. (Figure 1) Industrial sales for exports, in our view a more reliable gauge for underlying export strength, suggest China s exports were still growing around 7% y/y until end-2014, outperforming others in the region. A large part of the fall in imports was also due to lower commodity prices. Figure 1. China s Exports 250 225 200 175 150 125 100 75 Chinese New Year Day was on 31st Jan 2014 Circles mark the months of Chinese New Year Day 250 225 200 175 150 125 100 75 50 2007 2008 2009 2010 2011 2012 2013 2014 2015 Sources: CEIC, Pioneer Investments, as of February 20 th, 2015. 50 Meanwhile, deflation fears on the part of many investors have probably been overdone. Headline CPI inflation for January fell sharply from 1.5% y/y in December to 0.8% y/y. However, this did not signal weakening domestic demand, as almost the entire decline was directly attributable to a drop in food inflation caused by CNY distortion and lower global oil prices. Looking at the breakdown, there is no convincing sign that deflation in commodities is spreading into other items. (Figure 2) 2
China Macro Report March 2015 Figure 2. Contribution to Non-food CPI (%, YoY) Transport & Comm. Global commodity prices Tobacco & Alcohol Household Goods Recreation & Educ. Base effect in tourisml Healthcare Clothing Residential Property markets -0,3-0,2-0,1 0,0 0,1 0,2 0,3 0,4 0,5 0,6 Sep. Oct. Nov. Dec. 2014 Jan. 2015 Sources: CEIC, Pioneer Investments, as of February 20 th, 2015. Key Points on Economic Conditions China Macro Pulse Economic conditions are clouded by distortion of Chinese New Year. Downward pressure may come from control of local government financing. AGGREGATES GROWTH Policy stance is getting clearer, shifting to be relatively accommodative. Central government will probably increase budget deficit. The PBOC seems ready to use all necessary easing tools. FACTORS CONDITIONS POLICIES Policymakers seem to be more comfortable with slower but more sustainable growth, which comes with continued structural adjustment. WEALTH FINANCIAL CONDITIONS High leverage remains a top threat. China is adjusting strategy to rely on regulations to restrict credit in wrong sectors while keeping a relatively accommodative policy overall. Source: Pioneer Investments. Data as of February, 27 2015. 3
(% of GDP) China Macro Report March 2015 In our view, the policy stance is getting clearer. The central government is likely to increase its own spending to offset, partially, local government tightening. Policy Stance: Getting Clearer Despite a clouded economic picture, the stance of policymakers has been getting clearer, with an adjustment of strategy that combines a tightening of regulations to restrict funds channelled towards the wrong sectors with relatively accommodative overall policy. Fiscal: Local Government Tightening, Central Government Easing China s official budget does not include borrowing of local governments through financial vehicles. Taking this factor into account, the actual fiscal deficit has been much higher than official figures suggest. (Figure 3) Since late 2014, China has started to push fiscal reforms ahead by pledging to restrict out-of-budget financing of local governments. If fully implemented, it would cause a sharp slowdown of local government spending, weighing on the whole economy. That said, local media have reported that the central government will probably increase its budget deficit, and also seek to trim local government financing over a few years rather than all at once. This means that downward pressures should be manageable, although the overall fiscal stance is likely to be tight, weighing on infrastructure construction and commodity demand. Figure 3. China's Total Fiscal Deficit (Incl. Local Gov) 0-4 0-4 -8-8 -12-12 -16 2008 2009 2010 2011 2012 2013 2014 2015-16 Out-of-budget balance (local govn, PI est.) Official budget balance (PI forecast for 2015) Augmented fiscal deficit (IMF est.) Sources: CEIC, various government departments, Pioneer Investments, as of February 20 th, 2015. Monetary Policy: Easier Than Last Year The monetary stance seems to have turned relatively accommodative this year, beginning with a universal Required Reserve Ratio (RRR) cut, announced in early February. Policymakers will probably rely more on regulations to control credit channelled to the wrong areas, including sectors with serious overcapacity as well as local governments. The PBOC has been seeking all possible ways to support the right parts of the economy, particularly Small and Medium-Sized Enterprises (SMEs). With all tools likely now on the table, the PBOC can choose further cuts of its benchmark rate or RRR in case of serious situations. On a more regular basis, it is likely to use open market operations, lending facilities, re-lending programmes and other targeted measures to shore up the economy. This probably means that 1) market rates will remain at relatively low levels, and 2) the slowdown of credit growth is likely to be milder than over the last couple of years. 4
(% y/y) China Macro Report March 2015 In fact, growth in bank loans, which is more directly controlled by the PBOC, has already been allowed to pick up. This probably reflects policymakers intention to offset weakness in other forms of finance caused by tighter regulations on shadow banking and local government borrowing. (Figure 4) The monetary stance is shifting towards relatively accommodative. Figure 4. China s Credit Growth 40 35 30 40 35 30 25 20 15 25 20 15 10 10 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total outstanding credit ("Total Social Financing") Sources: CEIC, Pioneer Investments, as of February 20 th, 2015. RMB bank loans The upshot is that downward pressure on economic momentum is shifting from property towards local government spending, as China strengthens regulations on local government out-of-budget financing. That said, policymakers are also seeking ways to support the right parts of the economy, in our view by increasing central government spending and easing monetary conditions. This should help avoid a sharp slowdown of the economy with accompanying deflationary spirals. Ultimately, the key is structural reforms, where we continue to expect upside surprises over the next couple of years. Currency: Fears About RMB Risks Overdone The Renminbi has been under downward pressure over the last few weeks, touching the floor of its daily trading band against the dollar. This has caused market concerns about serious capital outflows and depreciation risks for China s currency. Looking ahead, however, we think such fears are probably overdone. Recent downward pressures on the Renminbi are largely the result of China s exporters reducing their dollar trade financing and increasing dollar cash, due to a shift of their views to a strong dollar. Such adjustment is likely to be gradual, given limited channels for short-term flows. Ultimately, we believe that the PBOC retains the strong ability to control the Renminbi s path, given its more than sufficient FX reserves and continued large current account surpluses, in addition to continued effective capital controls. Meanwhile, policymakers have shown no willingness to allow large swings of the Renminbi in either direction. On the economic side, there is still no urgency to boost exports, when China s exporters are still gaining market share. What s more, policymakers fears that any large depreciation could spur more capital outflows. On the political side, China s leaders have shown a strong incentive to push Renminbi internationalisation. A relatively stable currency would help build the country s reputation. 5
China Macro Report March 2015 In particular, later this year the IMF will conduct its twice-a-decade review of the basket of currencies in its Special Drawing Rights that members can count towards their official reserves. The current basket includes the dollar, euro, yen, and pound. It seems that China would like the Renminbi to be included as well. Although policymakers may allow a mild devaluation against the dollar due to weakness in the euro, they have shown no willingness to accept large swings in the Renminbi. As a result, we expect the RMB to be roughly stable over the course of 2015, with relatively small fluctuations during the year. The Renminbi is under downward pressure, but the PBOC seems to want and to be able to keep it from large swings against the dollar. Figure 5. Renminbi Exchange Rate (Against The Dollar, Onshore) 5,9 6,0 6,1 6,2 6,3 Falls triggered by PBOC, with Renminbi Stronger lowering reference rates 6,4 gen 13 lug 13 gen 14 lug 14 gen 15 The upper band Reference rate (set by PBOC at start of day) Market rate (closing spot rate) The lower band Sources: Bloomberg, Pioneer Investments, as of February 20 th, 2015. 5,9 6,0 6,1 6,2 6,3 6,4 6,5 Key Points on Stability Conditions China Macro Pulse Migration is slowing. Labour force is shrinking. Population is ageing. DEMOGRAPHIC XI Jinping has successfully consolidated power in almost all areas. This should help push economic reforms ahead. SOCIAL STABILITY CONDITIONS POLITICS Maintaining social stability is a major incentive for China s leaders to pursue structural reforms and an anti-corruption campaign. HEALTH Rebalancing is underway, although in early stages. External conditions remain resilient despite recent downward pressures from capital outflows and on renminbi. Capital controls remain effective, FX reserves are sufficient and China continues to run a current account surplus. Source: Pioneer Investments. Data as of February, 27 2015. 6
China Macro Report March 2015 Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of February 27, 2015. The views expressed regarding market and economic trends are those of the author and not necessarily Pioneer Investments, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Pioneer Investment product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: March 4, 2015. Follow us on: www.pioneerinvestments.com 7 0146_0215