Lower official growth targets in China

It is important for China to rebalance its economy. Crédito y Caución expects the announcement of further gradual economic reforms.
Analisis Credito y Caución
Madrid - 07-nov-2013

Overall, the domestic political situation in China is stable, with a smooth transition to the top positions of power: the appointment of new president and new Prime Minister. The new government has launched a campaign against corruption and extravagance by top party officials, which has led to the recent conviction on corruption charges of former Politburo members.

To prevent any major social unrest, the administration’s main aim is to preserve high economic growth to create jobs, combat inflation and develop a public welfare safety net. The protests and uprising in the Middle East and North Africa have made the Chinese government acutely aware of the potential for similar developments in China. While it has become more difficult to prevent public demonstrations and criticism of the government via the internet, a major difference between China and the affected Middle Eastern countries is that the living standards of many Chinese people have improved: GDP per capita has risen from US$ 847 in 2000 to US$ 7,559 in 2013. Nevertheless, there is sharp income disparity between the rural and the urban population, and between the coastal provinces and the Western parts of the country. In recent years, social discontent has grown in several provinces, fuelled by corruption in local government, environmental problems and weak protection of property and land rights. In many cases, farmland has been illicitly expropriated by the local authorities for commercial use but so far protests have flared up only locally and have been swiftly contained by the security forces.


Stable international relations, but growing Chinese assertiveness in the region

Sino-US relations are generally stable, despite some regularly emerging tensions over US arms sales to Taiwan and human rights issues. Little progress has been made in disputed Sino-US economic issues such as the exchange rate and the Chinese trade surplus. The Yuan is still linked to a basket of currencies and has slowly appreciated – but too slowly in the view of both the US administration and Congress, which are continuing to exert some pressure to accelerate progress.

During the last three years, the US military has become increasingly concerned about Beijing’s military build-up: especially the implication of China’s naval and air force capabilities for power projection in the Pacific. The recent shift in US defence strategy, with a renewed focus on Asia-Pacific, is motivated mainly by Washington’s aim to balance rising Chinese power in the region.

One issue is Beijing’s increasing assertiveness in the South China Sea, where it claims sovereignty over a large U-shaped area, bringing it into dispute with several neighbouring countries. Since 2012 tensions with the Philippines and Vietnam have increased again over disputed islands in that area.

At the same time, relations with Japan have deteriorated since 2012 over the Senkaku//Diaoyu islands claimed by both sides. Currently neither China nor Japan shows signs of compromise and regular incursions of Chinese ships into Japanese claimed territorial waters around the islands have increased the danger of a clash.


Lower official growth targets in 2013 and 2014

In 2012 Chinese economic growth slowed to 7.8 % year-on-year, after 9.1 % in 2011. Growth is expected to decelerate further, to 7.5 % in 2013 and 7.3 % in 2014, as investment and government spending decrease. However, economic performance will be sustained by rising private consumption, which will be supported by higher wages. Urbanisation is one of the government’s key ways of stimulating private consumption. With increasing domestic demand, import growth will outpace export growth and the external balance will detract from GDP growth.

Because of earlier tightening of monetary policy, inflation has fallen since late 2011 and is now expected to be 2.7 % this year, after 2.6 % in 2012. This modest inflation means that the central bank, the People‘s Bank of China, can maintain its relaxed monetary stance: it is possible that it will cut rates later this year to reduce financing costs for struggling Chinese businesses.

However, residential house prices have again increased sharply. In China’s biggest cities, prices increased almost 20 % year-on-year in August this year, despite the administrative measures already in place to constrain the surge in housing prices. As a result, affordable housing is currently a serious issue.


Monetary policy: gradual Yuan appreciation to continue

The Yuan is de facto fixed, with a crawling peg to the US$ that allows some fluctuation within a range of rates. The band in which the Yuan can move against the US$ each day has been widened to 1 % from its previous 0.5 %. It is expected that further appreciation will be gradual, as a faster rate would hurt the international competiveness of Chinese industries and exports.


Rising budget deficit

China’s budget deficit will increase as spending on social welfare services rises, but remains relatively low at 2.1 % of GDP in 2013 and 2014. Government debt is estimated to have been 16 % of GDP in 2012. However, some fiscal accounts are far from transparent and it is estimated that there are large contingent liabilities for the central government, especially due to the debt burden of local administrations.

Debt has increased rapidly since 2009: especially short-term debt by trade credit and trade financing. However, the debt ratio as a percentage of GDP is still good. The country holds enormous foreign reserves and its solvency and liquidity are sound, with ample capacity to make external payments.

With imports increasing, the current account surplus has decreased over the last couple of years, and this will continue in 2013 and 2014, as private consumption rises. The services account turned negative in 2011, with many Chinese holidaying abroad. Given the weaknesses in the financial sector, the liberalisation of the capital account will be gradual. In months of imports China has the largest foreign exchange reserves of any country, due to its strong balance of payments: 22 months of import cover in 2013.


Domestic risk factors – mitigated by strong liquidity and solvency

Although China is by no means immune to weaker external demand, the main risks to future growth are related to the internal market. Local government and the banking sector debts remain contingent liabilities for the central government. Public debt is currently moderate but, when contingent liabilities are taken into account - such as bank restructuring in the event of deterioration in the financial sector and future pension and social security costs - that debt becomes much higher.


The real estate sector

There are ongoing concerns that the perceived property overvaluation may be subject to sharp correction. Moreover, investment in real estate has been a major driver of economic growth in the past and a sharp price correction would have an impact on the whole economy via the banking sector and local governments.


A weak banking sector

The Chinese banking sector remains weak, as high credit growth in previous years could lead to deteriorating asset quality in the financial sector. Although non-performing bank loans are currently low [1 %], this percentage will inevitably rise in the medium term. Chinese banks played a prominent role in the massive 2008/2009 stimulus programme, and bank lending has increased sharply since then, including a large share of ’shadow banking’, resulting in high investment spending.

According to Fitch, the bank credit-to-GDP ratio was 136 % of GDP in 2012 and as much as 198 % of GDP when off balance sheet credit is included, compared to 125 % in 2008. Many loans have been rolled over instead of being repaid, and the questionable quality of assets in the banking sector is a source of concern. With no precise data of shadow banking activities available, the risks to the economy are difficult to assess. However, most activity is linked to the real estate sector, and there are concerns about the banks´ large exposure to the property market. Problems in the banking sector could spill over into the broader economy or even lead to the need for state intervention to support the financial system.


High local government debt

Closely intertwined with potential banking sector problems are the finances of local government bodies, which played an important role in the massive stimulus policy of 2008 and 2009. The debt burden of local governments has increased due to high investment spending, financed through borrowing by local government financing vehicles, often via the shadow banking sector. There is a lot of uncertainty about the quality of their investments and reports about high debt levels [Fitch estimates local government debt amounts to 25 % of GDP] have created worries about local governments´ financial health.

It is estimated that about 20-25% of local government investment companies´ loans are highly risky.

As land revenues are important for the funding of local government spending, any sharp downward correction in the property market could make funding difficult and would hurt the banking sector as large creditors.


Still room to stimulate the economy

However, in contrast to the situation in many mature markets, the Chinese authorities still have room to provide stimulus to the economy. The central government runs a minor budget deficit, public and external debt is very low, and China has huge international reserves. This creates a cushion for the economy in the event of any external or internal shocks, as the government has the financial muscle to take appropriate countermeasures.


Economic policy still focused on rebalancing

It is important for China to rebalance its economy. The enormous stimulus package of 2008/09 has aggravated the imbalances in the economy by promoting investment and this constitutes a major economic risk. Together with massive credit expansion over the past four years, inefficient investments have created a bubble in the property market.

As in 2012, the government is keeping to the official GDP growth target of 7.5 % for 2013, so that it has some leeway for economic restructuring. This - by Chinese standards - relatively low percentage is an indication of the government’s ambition to steer the economy towards what it sees as a slower, steadier and healthier growth pattern. Both President and Prime Minister have repeatedly emphasised that the government is ready to accept slower growth as it rebalances away from an investment-driven, export-dependent economy, to a more services-oriented and consumption driven economy.

Crédito y Caución expects the announcement of further gradual economic reforms at the Third Plenary Session of the Central Committee in November 2013, especially with regards to urbanisation, the liberalisation of the capital account, resource pricing and allowing private investment in some stated-owned monopolies. Such reforms would support industrial upgrading, provide more equality in income distribution and help to establish a more consumption-driven and services-based economic structure, further reducing China’s vulnerability to volatility in the global economy. With higher spending on social services, the government is trying to moderate the increasing social inequality as well as rebalance the economy.


About Crédito y Caución

Crédito y Caución has been the leading credit insurance provider for Spain's domestic and export sectors ever since it was founded in 1929. With a market share of 54%, for over 80 years the Company has contributed to the growth of businesses, protecting them from payment risks associated with credit sales of goods and services. Since 2008, Crédito y Caución is Atradius Group’s operator in Spain, Portugal and Brazil.

Atradius Group is a global credit insurance company active in 45 countries, with has access to credit information on more than 100 million companies worldwide. The global operator consolidates its activity within the Catalana Occidente Group.

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