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Notes from China

Being on the ground in China gives you a different perspective from the view in London. Policy moves that seem opaque and have been poorly communicated become clearer. Here are a few of my thoughts from my recent trip to Beijing, Chengdu and Shanghai.

While Beijing’s incremental policy response may be unfamiliar and confusing from the outside, on the mainland the intention is clear: underlying all China’s economic policy lies the desire for social stability. The authorities have little tolerance for fluctuations in the business and financial cycles to the downside, which could result in rising unemployment. This goal was clear in China in October, but it has now been underlined by President Xi Jinping confirming Beijing still intends to achieve its goals of doubling people’s average income and the size of China’s economy between 2010 and 2020, which would require a minimum of 6.5% GDP growth annually for the next five years.

Maintaining stability and achieving the growth target, will be a major challenge for Chinese policymakers over the next 12 months, particularly as it is not yet clear that consumer spending will be able to take up the slack of the slowing manufacturing economy. With the new five year plan commencing in 2016, we could see some outperformance of economic activity versus expectations as new projects announced in the plan get front-loaded in order to buoy growth.  

However, the desire to maintain stability will likely mean that the pace of reform will slow. The relatively fragile state of the economy and the global implications of so-called big-ticket reforms, like the change in the fixing methodology of the renminbi on 11 August, have reduced the State Council’s appetite for immediate change. We’ve already seen how stability trumps reform, with some backtracking on fiscal policy, financial market, foreign exchange and monetary policy and capital account reform all within the last few months. Eventually, policymakers will roll out much-needed reforms, but they will try to wait until conditions are more conducive.

But Beijing’s desire for stability might be undermined by some potentially concerning trends in China’s capital markets. With the ongoing challenges in the equity and property markets, more capital is being allocated to fixed income as monetary policy remains on an easing bias. Given the current relatively low yields, to get more bang for their buck some investors, particularly managers of wealth management products (WMP), have been resorting to buying of bonds on a leveraged basis (we heard reports of WMP leveraging from anywhere between two and nine times). Now that the equity market is recovering somewhat, the concern is that investors will start to sell duration again for equities, tightening financial conditions as yields rise, offsetting the transmission of counter-cyclical policy and potentially crimp growth further. This situation has become more acute since the summer’s sell off in the equity market, with the potential to result in a very volatile cycle of asset price swings.

On the positive side, on 30 November, the International Monetary Fund announced that the renminbi would be included in its Special Drawing Rights (SDR) basket of currencies from 1 October 2016. It was clear from our meetings that this was going to be a political, rather than an economic decision, so we don’t expect this to be a game changer in terms of its implications for the short-term evolution of China’s macroeconomic policy framework. Nevertheless, at the margin this will bring in more flows via the capital account via reserve rebalancing from global reserve managers.

On the whole, it is a mixed picture and Beijing has its work cut out to maintain the economic stability that it seeks. 

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