By Roger Mark, Product Specialist and Wilfred Wee, Portfolio Manager
The last couple of weeks have been busy for China watchers – from the announcement of the removal of presidential term limits to Trump’s tariff announcements and the opening of the two-week National People’s Congress (NPC) at the weekend. Here are the key investment takeaways from the last week:
- Short-term macro stability remains key, but we have greater confidence that we will see a renewed emphasis on structural reforms.
- Beijing will likely tread carefully on trade; there are real risks of a global trade war, but there is a strategic opportunity to reposition China at the forefront of the global trading system.
- Political changes should enhance the decision-making progress over the near term, but raise long-term concerns about the future governance of the country.
Short-term macro stability, with a renewed emphasis on structural reforms over the medium term
- As part of the opening of the two-week session of the NPC, Premier Li Keqiang announced the targets for the year. The key numbers were generally as expected.
- The growth target was kept at 6.5%, but the removal of the phrase “higher if possible in practice”, suggests greater realism in respect of China’s potential growth. Our nowcast in Chart 1 points to near-term stability around that target, albeit with modest downside risk as a natural result of some of the financial regulatory tightening and industrial capacity cuts. However, Chart 2 shows potential growth continues its moderating trajectory.
- From a monetary perspective, the inflation target was kept at 3% and quantitative targets for bank lending, total social financing and M2 growth were removed for the first time since 2009, suggesting that resource allocation around monetary policy is graduating from a quantitatively-anchored system to a much more price-based one. Instead, they will be maintained at an “appropriate” level of growth.
- The formal budget deficit target was lowered to 2.6% from 3% the year before – a signal of the macro tightening bias as the economy moves away from the downside risk in the 2012-2016 period.
- Finally, the introduction of an unemployment target – linked to both registered and unregistered workers – perhaps reflects the growing importance of employment in ensuring the regime’s legitimacy as China moves away from the transformative high growth era.
- If the targets pointed to continued focus on short-term stability, there were also announcements relating to more structural changes: further easing of foreign ownership limits in financial services and expansion of foreign access into other sectors such as telecommunications. Moreover, the government also reiterated its commitment to supply-side reforms.
- Indeed, with this being the first NPC since the 18th Party Congress, the coming days will be carefully watched for new appointments and further details on the structural reform agenda.
- Economic policy is likely to be placed under the overall responsibility of Liu He – a key ally of President Xi Jinping. He is set to be named vice premier for the economy and financial sector (and according to some reports possibly the next governor of the People’s Bank of China). If the local press is anything to go by, he will head up a highly experienced economics team drawn from senior roles across the country’s financial system.
- This bodes well for the reform agenda, and while investors have been disappointed with the scope of reforms since the overpromises of the 2013 third plenum of the 18th Party Congress, there are reasons for thinking the reform agenda may finally start to accelerate:
- The focus in recent years was on ensuring stability – first in reaction to macro weaknesses and then in the run-up to the 19th Party Congress. Policy-making can become more ambitious now.
- Xi has consolidated power significantly – his allies dominate the Politburo and the Central Committee’s Leading Small Groups.
- This concentration of power together with the trust Xi’s economics team has earned in the run up to the 18th Party Congress, bodes well for more far-reaching decisions in the months ahead.
- Overall, the policy direction seems to be as it’s been for a number of years: short-term stability, medium-term reform. But this time the reform agenda may actually exceed investor expectations as Liu promised at Davos. We expect greater focus on private sector investment, aimed at innovation and upgrading. This will be a big challenge, but it would be a huge multi-year growth driver.
- In addition, it looks like there will be further focus on the delivery of improved social (inequality, housing) and environmental governance.
Chart 1: China GDP nowcast
Econometric modelling is inherently imperfect and not a reliable indicator of future results.
Source: IAM, Haver, Bloomberg as at 28 February 2018. Nowcasting models are used to predict short-term economic dynamics. Nowcasting estimates are based on our proprietary dynamic factor models using third party data. These models are only utilised as part of the team's wider investment analysis.
Chart 2: China finance neutral trend GDP growth vs. actual
Source: IAM, Haver, Bloomberg (as at 28 February 2018)
Trade war risks and a strategic opportunity for China
- Trump’s tariff announcement coincided with Liu He’s visit to the White House to discuss trade.
- The steel and aluminium tariffs that Trump announced were ostensibly aimed at China given the national security pretext, despite the impact being much greater on America’s allies and neighbours.
- Aluminium and steel make up a negligible part of the bilateral trade deficit. This helps to explain the tempered response so far from Beijing. It also arguably reflects China’s self interest in ensuring calm in the global trading system. Trump’s trade policies present a strategic opportunity for China to strengthen trade relationships and links with countries that have traditionally been within the US sphere of influence.
- However, the Trump administration is unlikely to be finished with its protectionist trade agenda and significant targeted action against China is very likely in the future. The fact that Trump refused to meet Liu He last week speaks volumes – this was a snub aimed at President Xi. The key development we will be monitoring is the recommendations from the US Trade Representative’s investigation under Section 301 of the 1974 Trade Act into intellectual property and technology transfer. On the back of the findings, President Trump has wide discretion to impose significant protectionist measures. It’s hard to make a call on White House policy at the moment, but it is likely some sort of action under section 301 will happen in the coming months. Trump has until August to make an announcement.
The ending of term limits poses concerns over the long term
- The abolition of term limits of the presidency is simply the latest victory for Xi in his consolidation of power.
- If Xi stays on as president it is highly likely that he will stay on as General Secretary of the Communist Party beyond the current age limit. (This is where de facto power lies since the end of the Deng era.)
- The message is thus clear: the era of term limits and age limits are coming to an end. These have served as an effective check on the leadership of the Chinese Communist Party (CCP) since the Deng era to prevent another Mao or stagnation into Soviet-style gerontocracy. The CCP will have to find new norms, or risk the dangers inherent in despotism. The lessons from history are hardly encouraging. Thus while we are encouraged about the shorter-term impact of more effective decision-making on macro-economic reform, the removal of term limits is a negative for the country’s long-term development path.
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