CHINESE DREAMS, GLOBAL REALITIES AND A CUP OF TEA

A common practice of Chinese tea culture is for the beverage to be served to a senior member of a family or organization as a show or respect. Yet there is a twist in the centuries-old plot. In Nowadays China, where an unprecedented social and economic shift is underway, parents may pour a cup of tea for their children to show care. Or a boss can offer a hot cup for subordinates. Then again, on formal occasions, the basic rule remains: tea-serving is a bottom up ritual.

No wonder all eyes were on Chinese president Xi Jinping when he paused during a three hour speech at the Chinese Communist Party’s congress for a sip.

The party’s bigwigs, seated behind their leader on stage, waited and watched. And so did millions of citizens and a slew of analysts worldwide. Would the man heading the world’s second biggest economic powerhouse deliver some big statements as he charts a path for the next half a decade and beyond?

And deliver he did. 

Xi envisioned wiping out poverty, bridging income gaps, turning China into a developed nation. Overhauling global trade and combating global warming were also feted in front of delegates and the media.Big Words for the Future

Ambitious long-term commitments and at-times lofty declarations also raise questions. Here is one: What concrete steps does China aim to take?

And here are three answers.

First, there is the issue of accelerating the economic rebalancing, which remains pivotal. The authorities have made good progress in pivoting the economy from exports to domestic demand, from industry to services. Yet low growth in private investment (+6.4% y/y in the January to August period) may act as a drag in the long run. Supportive fiscal measures – we expect the fiscal deficit to reach -4.2% of GDP in 2018 – and further efforts to upgrade the economy such as the Manufacturing 2025 strategy will be crucial. 

Second, corporate debt reduction and State Owned Enterprises (SOEs) reform  will become ever more important. While non-financial corporate debt is high (165% GDP) SOEs reform could generate fairer competition and diminish market distortions. Financial authorities tighten regulation to reduce leverage growth and the government launched a debt-equity swap to help corporate deleveraging. It also announced a mixed-ownership reform to diversify large companies’ shareholdings and orchestrated SOEs mergers. Yet these measures yield few tangible results so far due to limited implementation and continuing state intervention. 

Then there are trade strategy and financial liberalization. On trade, authorities will stress the benefits of the Belt and Road Initiative (BRI), which should gather 65 countries, 4.4bn people and around one third of global GDP. This will help Chinese companies internationalize, reduce overcapacity and improve access to local suppliers (Mongolia, Myanmar, e.g.). It will also position China as a globalization champion. On financial liberalization, there is room for improvement. As a reaction to the 2015 stock market turbulence and capital outflows, capital controls were beefed up to prevent the renminbi from depreciating. Lately, the economy is doing better and pressures on the RMB have diminished. Thus, the authorities could become less “defensive” and embrace further reforms to open the economy. 

Modest Short-term Adjustments 

Priorities and even concrete plans are one thing. But what are the potential short and medium-term implications such strategies could have?

Expect little impact of the Congress on macroeconomic and financial aggregates in the short-run, measures to address shocks have been implemented beforehand. 

First, macro-policies have been supportive since the beginning of the year to ensure that economic growth target (above +6.5%) is met. Economic growth rose by +6.9% in H1 and we expect a growth of +6.7% in 2017. 

Moreover, the so-called “national team” of state owned investors will be ready to intervene if there is a shock on the financial market as they did in during the stock market collapse of 2015. Last but not least, the PBoC will likely adapt its policy to ensure that there is enough liquidity in the system. It will support the currency if pressures were to increase. The government already sees the first impacts of their commitment to reduce financial risk. Shadow banking flows decrease (see chart below), credit growth slows and real estate prices growth decelerates. 

On the other hand, growth in capital intensive activities slows; more fragile economic agents (private sector and SMEs, e.g.) start to experience difficulties due to tighter credit conditions. The Caixin – Markit PMIs, which are good indicators of private sector mood, decreased in September. Caixin-Markit Manufacturing PMI decreased to 51 in September (from 51.6 in August). The services index fell to 50.6 (from 52.7 in August).

Tea Time 

The numbers are staggering, the stats may be at times opaque and big words do not lend themselves easily to analysis. So where does this leave the discerning observer? Will the big Chinese adjustment take place over the next five years? 

Time for a Chinese proverb, then: "A hasty man drinks his tea with a fork."

Ludovic Subran 

Chief Economist 

Euler Hermes 

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