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The Chinese Economy

by internationalbanker

By John Manning – john.manning@internationalbanker.com

The predominant concern for Chinese leaders and economic advisers at the moment is growth. Recently reported at 7 percent, national economic growth has more than halved over the past eight years; with 2007 levels of growth reported at 14.2 percent, this marks a significant slowing of development into the future for the global economic powerhouse. Growth has been reported in line with Chinese official expectations yet still poses a challenge for sustainable growth for the years ahead. The central bank—the People’s Bank of China (PBC)—has been executing a number of strategies to help drive growth upwards whilst also improving the stability of the Chinese economy. 

As an example, and a core element of monetary-policy action, the central bank has delivered a series of interest rate cuts to help facilitate the ease of cheaper borrowing and stimulate investments and wider economic activity nationwide. The Chinese base interest rate is currently 4.85 percent, and this rate been cut four times in the past seven months. Inflation concerns are also high on the agenda for the PBC, which hopes that interest rate cuts will help remedy the situation by boosting borrowing. The reported annual inflation rate moved upwards from 1.2 percent in May of this year to 1.4 percent in June, and consensus forecasts are indicating inflation to be 1.9 percent for 2015. These figures are falling short of government target levels, which were set at 3 percent for 2015. Meanwhile, growth is expected to remain around the 7-percent level over the course of the next three years. 

Beijing, China skyline at the central business district.

The Chinese government and public-sector officials still control the majority of the financial system’s operations in China. A number of policies have been set in place to help the banking sector develop and operate at its most efficient level, given national economic conditions. Key goals of banking-system strategies are to improve access to regulated financial bodies and liquidity. Interest rate cuts have proven somewhat lacklustre in terms of impact on economic output to date. Therefore, the PBC has turned its attention to reforming the banking system and in June of this year proposed a draft amendment to the commercial-banking law that will remove the long-standing 75-percent loan-to-deposit ratio in the banking sector in order to boost lending. This policy measure will help businesses receive better access to lending and will also boost bank business overall through less-restrictive working conditions. Further to this change, the PBC has also suggested a reduction of 50 basis points in the reserve requirement ratio (RRR) that currently applies to commercial banks. 

Local market participants and economic experts remain concerned that, although a step in the right direction, these measures may prove too little too late if the goal is to provide system-wide stability as well as to boost investor confidence and growth in sizeable measure. Interest rate and reserve requirement ratio reductions have the potential to drive business profitmaking as well as support economic fundamentals; however, the issue of low demand for loans remains significant, and this is holding back development traction.

National officials argue that eliminating the loan-to-deposit ratio will lead to accelerated credit growth, and the cut to the RRR will allow more funding to reach the rural sector. This policy change will also help small businesses and individuals—factors that will reap stable, long-term economic rewards down the line. Structural economic factors remain a challenge in China—with the state controlling the majority share of business activities. Public-sector control has historically not proven to be the most efficient for most other nations of comparable economic size. Allowing the private sector and free market to play a larger role in the workings of China’s economy might create positive knock-on effects if the country’s political leaders can find a way to work alongside private-sector executives towards meeting common, mutually beneficial goals. In the meantime, further rate cuts are likely as well as a number of further fiscal and monetary policy measures. Given the high chance of the US interest rates being increased later this year, it is likely the PBC will continue to cut the RRRs rather than interest rates. 

As part of an effort to make China a more open and free market, national leaders and authorities have been taking steps over the past year that may help make Shanghai a global financial hub. These parties have been boosting Shanghai’s role in the international arena—removing certain obstacles to investor access, for example, and investing heavily in the development of related infrastructure and technology. However, recent turmoil in the Chinese stock market has had a damaging effect on the levels of investor confidence in this area of investment. Since the start of the year, the Chinese stock market soared 150 percent higher—up until June, where in the space of a few days a third of the value of the stock market was wiped out. Over a timespan of merely a few weeks, China’s stock market lost a mammoth amount of value, $3.4 trillion, and the Shanghai index has furthermore lost 32 percent of its value since mid-June levels. The Chinese stock market had been heating up since January, as small investors sought higher returns for their money. The Chinese stock market is supported to a significant degree by small retail investors, and these investors have been exposed to the volatility and wild swings in the value of their investments over the past few weeks. The crash of the stock market is underpinned by the worryingly high amount of debt that investors have been taking on. 

China is still facing challenges when it comes to a transparent and fully regulated lending market. Investors, both large and small, seek leverage in both formal, lit, regulated channels as well as informal, often unregulated shadow-sector channels. This type of financial activity poses greater risks to both the stability of the financial system as well as to investors who are not fully aware of the risks to their money. The recent turmoil in the stock market revealed that a large number of investors had borrowed money to invest in the stock market, and when huge swathes of value were wiped away, these investors risked losing all their wealth and defaulting on their debt repayments. These investors began panic selling, worried in part by the probability that they would not be able to meet their debt repayments if they did not exit their investments in time. Access to these various questionable sources of lending have been partly to blame for the surge in stock market prices since the start of the year—and this cycle has the potential to create a debt bubble large enough to impact the global marketplace through future price and volume activity shocks. In this most recent case of a market crash, exchange authorities and the Chinese government intervened swiftly to prevent the market crash gaining further momentum and causing more damage than it already had. By restricting trading activity and banning selling, the outflows were stymied. 

Improved transparency and comprehensive lending regulation measures need to be set in place by the Chinese authorities to build a more stable foundation for the banking and financial sectors of China. Although the stock market has seen a sizeable recovery of the losses made through the crash period, there has been an underlying negative impact. Investor confidence has been eroded. The Chinese leadership has a history of mysterious and indirect approaches to market intervention. This track record has led market commentators to believe that regulators failed to prevent the bubble forming in equity markets, in an irresponsible attempt towards continuing the pattern of gains.

The current Chinese president, Xi Jinping, has made a number of promises to the Chinese public—announcing a goal of creating a new era of prosperity and greatness for the Chinese people. Under a policy title of the “Chinese Dream”, he has spoken about rebuilding China’s historical glory under his leadership. Although he has spoken well on the matter, signs of vulnerability have materialised in his strategic measures. As an example, during the early days of his term, President Xi Jinping made a fresh commitment to allowing market forces to play a more “decisive role” in China’s economy, and yet at each significant economic event we see state intervention. Historically a communist-leaning nation, this type of promise was bold and revolutionary. However, there is yet to be any major evidence of policy implementation meeting this commitment head-on. State intervention remains a problem for the Chinese economy—as it often acts to undermine itself, leading to more problems than it originally intended to circumvent. China’s economy has been heavily dependent on public finances and infrastructure spending over the past few decades—a strategy that has proven effective and led to rapid economic growth and expansion. This expansion was underpinned by successful state-owned enterprises and high levels of exports produced by cheap labour. China’s economy has now moved into a phase of new economic conditions—the policies of the last few decades will not be effective in this climate. President Xi Jinping has identified a need to direct China’s economy towards a consumer-based, private-capital-supported, innovative economy. However, as part of this drive the president himself, alongside his deputy, Premier Li Keqiang, began encouraging Chinese citizens towards new areas of risk-taking—such as investing in the stock market. The goal of this action was to aid capital-raising efforts whilst expanding the role of the private sector. The knock-on effects were hoped to be increased employment, boosts to consumer spending and improved investor confidence—helping fuel a positive cycle within Chinese capital markets. 

However, the recent market turmoil has left the middle classes suffering disproportionately from significant wealth destruction as well as market-confidence erosion. State-controlled media announcements encouraged aspiring middle-class citizens to put money into the stock markets, which created the equity-market boom during the first six months of this year. When the market crashed, millions of middle-class citizens and urban dwellers lost the bulk of the wealth that they had invested in the stock market, in part due to media and state encouragement. Although the stock market is still above where it started this year, these events have highlighted instability and uncertainty within the Chinese financial marketplace. The stock market is heavily invested in by small retail investors who are not fully aware of the risks, and in many cases they are leveraged significantly. These investors are at high risk of falling into financial default if these types of tumbling price events surface again and potentially persist for longer periods of time. This event has re-highlighted one of the key issues of the Chinese banking system: lending. A system of shadow banking still pervades the world’s most populous nation. In the meantime, the volatility of the stock market does not appear to be negatively impacting growth. Consumer-spending growth figures remain in line with expectations. In this area, it appears that government intervention through the times of price tumbles has resulted in the desired effect. 

Although the stock market continues on a rocky road and general economic growth levels are slowing, the property market is in fact seeing some positive momentum, representing an increasingly attractive investment opportunity for investors. The Chinese property market has been pulling out of a persistent slump period since the start of this year. In particular the profile of buyers driving improved demand has been shifting so that a greater share of the market is being taken up by owner occupiers rather than speculative investors—creating a signal of stability in property market growth rather than of a high-risk bubble. Since the stock market crash, investors have unsurprisingly added to the property market growth as well as stock market falls, as many of those investors who did not lose all of their wealth are seeking to exit the stock market and enter a more stable investment vehicle; they are turning to property. Building, sale and outfitting apartment transactions within the housing sector account for approximately one-quarter of China’s gross domestic product. Therefore, one of the key factors of slowing growth in the Chinese economy has been the property market—which has been in a growth slump over the past years and fell to a six-year low in the final quarter of the past financial year. Since the start of the year, the property market has shown signs of a turnaround. House prices in China grew at their fastest monthly rate in more than one and a half years as recorded in June of this year, indicating that this key growth driver of the Chinese economy is finally coming out of its year-long slump. Average house prices increased by 0.56 percent in June 2015 as compared to May 2015, according to data from the China Index Academy’s survey of 100 cities. However, analysts are forecasting that the growth in the property sector will be slow and steady—rather than rapid and overheated. The improvements in the property market have come in part from lower interest rates—helping buyers gain access to more affordable mortgages. Further to this, less restrictive reserve ratios for banks means they are more capable of offering mortgage solutions to buyers—adding liquidity to the overall home-buying market. This growth in the property market will help improve national GDP, albeit in slow and small measures for now. 

Local government authorities have also taken some active steps towards stimulating the housing market. For example, Xi’an, part of the central China region, recently changed regulations such that non-native homebuyers buying apartments exceeding 90 square metres in size may obtain residence permits for the city. These permits allow buyers access to local welfare benefits and incentivise buying significantly. A first-quarter survey of housing data from the central bank indicated that 14.7 percent of residents stated their plans to buy a house within the second quarter of the year. This rate is up from the 13.8-percent rate that was recorded in the prior quarter. Investors across the nation are keeping a keen eye on the property market as a stable opportunity, as are home buyers entering the market in larger measure. Further adding to the success in this area of the Chinese market, on June 1 global credit-ratings agency Moody’s upgraded China’s property sector outlook from negative to stable. 

Into the future, there are still a lot of question marks around the Chinese economy and marketplace operations. Political uncertainties remain, and although political leaders continue to operate in mysterious and often inconsistent ways, they have stated their intentions to allow greater growth and access in the private sector. How well this will be achieved is yet to be determined—not enough time or effort has passed for significant change to be evident when it comes to a reduction in state intervention in the Chinese market. Government action leapt to action in moderating the stock market crash by halting trading and banning selling, and this successfully restored some stability to the market. The state leaders took rapid action to impose caps on short-selling. They also introduced a temporary suspension in public offerings, encouraged pension funds to buy more stocks to prop up the market, while the central bank was pushed to increase liquidity and cut interest rates further. However, this dramatic course of action has fuelled suspicions that the party is not as committed to free-market mechanisms and enterprise as their statements suggest. This action has left investors confused as to where their political leaders stand and what their next actions may be. Meanwhile, the stock market volatility has left investors less confident in investing in the Chinese market. On a global platform, investors remain equally confused, wary and lacking in confidence. The government is operating in new terrain—and China is going through somewhat of an experimental phase. Nimble and agile reactions to conditions will be the key drivers to success and development. However, without clarity and transparency, investors and market participants are not able to remain as flexible to market conditions as they could be with clearer information and direction from the country’s leaders and key markets. 

Entrepreneurship is a vital ingredient to China’s future. However, new businesses require access to capital in order to flourish, and instability and a lack of confidence in the capital markets will hamper progress in this arena. Clear political actions help build a clear trajectory for economic policy and direction, encouraging businesses and individuals to take well-measured risks. Monetary-policy measures from the central bank alone will not be enough to keep growth alive within the nation. Further interest rate cuts are expected from the People’s Bank of China. However, this will prove difficult to manage on a global scale as potential interest rate rises from the US towards the second half of this year may lead to a trend of capital flight from investors looking for an enhanced risk-reward profile for their investments. 

However, it is far from all doom and gloom for the Chinese economy. The stock market may have crashed, but it is still 80 percent higher than it was this time last year. The crash’s effect on a global scale was minimal, especially when compared to other global economic powerhouse nations, if they had undergone similar market falls. These are good signs that the Chinese economy is able to succeed on a global platform. The property market has the potential to boost GDP, and this may lead to wider economic development as a greater number of citizens get on the property ladder and benefit from stable, positive returns on investment—helping them to progress economically, driving further spending and business development. The next big challenge, one which has been at the top of China’s agenda for a number of years now, is to build confidence in the Chinese market. The fundamentals are in place for an increasing number of Chinese businesses—both private sector and state-owned. As more start-ups develop, investors, both domestic and global, need to be reassured that their money is being placed into a sound and properly operated system. The government and PBC should work towards a more comprehensive regulatory system to help businesses and individuals carry out financial activities with improved efficiency and recourse. For now investor confidence has taken a blow; however, this is not an unsurmountable hurdle for China’s economic and political leaders. With swift and firm policy action, the structural conditions are in place to enhance China’s role within the global free enterprise arena, just as President Xi Jinping has envisioned for the “Chinese Dream”.

Photo Attribution: © Depositphotos/wangsong
Photo Attribution: © Depositphotos/sepavone


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