Predicting China’s 2018 Economic Priorities

The priorities of the world’s second-largest economy are quite likely to shift in 2018, as those in charge of overseeing the Chinese economy seem to prefer a more cautious approach focused on protecting against the threat of a potential financial crisis. As a result, stimulating economic growth is no longer the chief concern of Chinese officials. According to several economic analysts familiar with the new priorities of the government, China’s 2018 economic growth target will remain somewhere around 6.5 percent, unchanged from the target set for the previous year.

Over the past year or so, China has sharpened its focus on limiting capital outflows and tracking down any potential “gray rhinos” — the unaddressed and eminently solvable threats that left unchecked might undermine the country’s manufacturing-driven economy. After capital outflows reached an unprecedented $725 billion in 2016, China instituted several policies designed to limit capital outflow. Those policies, as evidenced by the continued improvement in the nation’s foreign reserve funds, are rightly viewed as successful in achieving the government’s desired outcome.

This risk-averse approach is not necessarily welcome news for the local government officials with growth targets that still need to be met. In order to carry out its economic agenda, however, the current administration has expressed a clear willingness to part with any government official who disagrees with the economic plan as it currently exists. Given its firm belief in the course it has charted, it’s fair to predict that China will keep its interbank interest rates high while implementing additional policies intended to keep its money supply growth in check (a rate of 7 or 8 percent is a reasonable estimate).

China is also quite likely to reduce the pace of infrastructure growth, with its longstanding debt concerns representing the principal reason for the reduction. It’s also likely that the country will continue to shift its focus from an economy built on manufacturing to a consumer and services-based economy. As a number of other analysts have pointed out, growth stemming from such a shift is unlikely without further effort to promote the change, with tax cuts being the most frequently suggested strategy for realizing the potential gains of the ongoing economic transition.

Although Chinese officials are adopting a risk-averse approach with the goal of preventing a financial crisis, most authorities remain confident in the country’s ability to create a protective barrier around its financial and economic systems. In the view of these officials, such a barrier — along with the cautious economic plan it has outlined for this year — will effectively limit the impact of any internal or external shocks in 2018 and beyond.

Chinese Interest in US CRE Grows Following Trump Election

Trump’s election and pro-growth rhetoric are sparking heightened investment interest in US commercial real estate (CRE), especially as expectations of dollar appreciation grow. Much of the increased demand for dollar-denominated assets, particularly in commercial real estate, has come from China where the yuan has depreciated and economic growth has been slowing.

“(Investors) are seeing the U.S.commercial real estate marketplace as really standing out on a global basis,” said Hessam Nadji, CEO of Marcus and Millichap, to CNBC. “It’s not being overbuilt; it’s been very well balanced in this particular cycle in terms of loans that are not going up, the leverage that was very well balanced. They’re at much lower risk at this stage of recovery than we’ve seen in the past.”

The dollar appreciated considerably following Trump’s win, hitting eight-year highs against the yuan, leading to a flurry of speculation regarding US commercial real estate. Much of the foreign investment in US commercial real estate has been directed toward major metropolitan hubs including New York, Los Angeles (where Chinese developer Greenland has over $1 billion invested), San Francisco, and Chicago.

“The expectation is inflation will go up, job growth will improve and therefore commercial real estate becomes a better hedge in that scenario on a longer-term basis,” Nadji added.

In all, Chinese investment in foreign real estate reached $16.1 billion in the first half of 2016, double the figure from the same period in 2015. Investors at the recently-concluded 3rd Real Estate Globalization and Overseas Investment Summit in Beijing discussed growing opportunities in overseas investment. Henry Zou, founder of the Henry Global Consulting Group, encouraged attendees to prepare for stronger Sino-US ties in 2017,  anticipating that the Bilateral Investment Treaty between the world’s two largest economies would be ratified.

However, such overseas investment may be hampered by a Chinese government wary of massive capital outflows. In late November, China’s National Development and Reform Commission, The People’s Bank of China, The Ministry of Commerce and The State Administration of Foreign Exchange issued a statement warning of higher scrutiny of outbound investment. They are expected to pass stricter controls for foreign investments exceeding $10 billion, and for property deals by state-owned firms exceeding $1 billion, according to the Wall Street Journal.

Such regulatory controls may make it more difficult for Chinese firms to make large-scale real estate deals in the US, and may also hurt in-progress development projects that rely on Chinese capital.

References:

www.forbes.com/sites/elyrazin/2016/12/22/5-commercial-real-estate-trends-to-watch-in-2017/3/#6ce4fcee6b4e

http://www.forbes.com/sites/kenrapoza/2016/12/05/what-chinas-capital-controls-mean-for-global-real-estate/#44ca965041e5

http://therealdeal.com/2016/11/29/big-chinese-investors-rethink-some-us-real-estate-bets/

http://www.wsj.com/articles/chinese-developers-reassess-u-s-projects-1480435760

http://www.cnbc.com/2016/12/22/chinese-money-moving-to-us-commercial-property.html

http://www.globaltimes.cn/content/1022358.shtml

China’s Debt-Fueled Growth

The Bank of International Settlement (BIS) issued a dire warning earlier this year, opining that a full-blown Chinese banking crisis could be lurking on the horizon. In its September quarterly report, the BIS said that China’s credit to GDP ratio- which measures bank lending against the size of a country’s economy- had reached 30.1, the country’s highest to date. In the context of sluggish economic growth, the risk of individuals and corporations defaulting on their loans rises, increasing the risk of a banking crisis.

China’s soaring debt levels have been the subject of much concern and speculation. Outstanding loans have reached $28 trillion, as much as the commercial banking loans of Japan and the US combined. Total Chinese debt rose to 255% of GDP at the end of 2015, marking a 107% increase over eight years, and currently stands above 260%. Corporate debt alone is 171% of GDP. Worryingly, these figures do not account for the billions in Chinese shadow banking activity occurring outside of the formal banking sector.

According to Ambrose Evans-Pritchard of the Telegraph, these debt levels are “enough to threaten a worldwide shock if China ever loses control”, making China a global epicenter of risk.

Though economists and regulators have entreated China to ramp down its debt, China has relied on this debt to fuel and sustain its economic growth, which has slowed down significantly. In just the 12 months leading up to September 2016, China took on more credit than it did in 2009, when it implemented a great bout of stimulus spending in response to the recession. Property transactions and car sales in China have also ballooned.

The Chinese government is undoubtedly aware of the risk and has sounded warnings about the ballooning national debt through state mouthpieces such as the People’s Daily. However, it has yet to take any concrete action and is perhaps unwilling to deal with the political costs of slowing growth and laying off workers in order to rein in its debt. China’s bank system is also largely state-controlled, meaning they would likely be bailed out in the event of a crisis.

References:

http://www.bbc.com/news/business-37404838

http://www.telegraph.co.uk/business/2016/09/18/bis-flashes-red-alert-for-a-banking-crisis-in-china/

http://www.wsj.com/articles/chinese-debt-soars-into-space-1473755429

http://www.bbc.com/news/business-37114643

China Is Not In A Housing Bubble, Says Macquarie Economist

Contrary to popular belief, the Chinese housing market is not in the midst of a massive bubble, says Larry Hu, head of China economics at Macquarie Securities Ltd., according to Bloomberg. Rather, he contends that skyrocketing housing prices in China’s largest cities are the result of a shortage of supply coupled with consistent demand growth and immigration.

China’s largest cities have experienced drastic surges in housing prices in recent years. According to the New York Times- which reports that “China is in the midst of a dizzying housing bubble”- Shanghai’s average housing price has jumped by one-third in the space of a year, with Beijing and Guangzhou seeing similar increases. Shenzhen, another major Chinese city, has experienced a stunning 60% spike in housing prices within the past year.

At the same time, long-term housing loans (including mortgages) doubled their share of total official bank lending this year, growing from 20% at the beginning of the year to 40% in August, fueling fears that Chinese property is one of the biggest bubbles in history.

However, Hu notes, many smaller cities have not experienced similar housing price gains.“The difference between over investment versus mismatch is the single most important thing to keep in mind when thinking about China’s property sector, as these two views have vastly different implications for investment and government policy,” he wrote.

Hu also observes that larger cities have consistently experienced net immigration with only a limited supply of property entering the market, which leads him to declaim, “this is not a bubble; this is a shortage of supply.” Broadening the scope of focus to include smaller cities yields the surprising insight that housing has become more affordable at the national level, due in part to rising incomes.

As for the largest cities, Hu notes that continued migration into urban areas has maintained a steady floor on housing demand. At the same time, he believes that market-cooling measures imposed by municipal governments ought to mitigate at least part of the risk.

Since September 30, as many as 22 of the largest Chinese cities have passed market-tightening regulations such as raising the down payment on homes to around 30%, raising taxes on additional property purchases, and restricting non-residents from buying property. Such moves are likely driving the decline in China’s home sales that occurred in the first two weeks of October.

References:
http://www.bloomberg.com/news/articles/2016-10-17/what-bubble-china-s-home-prices-driven-by-demand-investment-mismatch

http://www.scmp.com/property/hong-kong-china/article/2029342/chinas-home-sales-decline-governments-market-cooling

http://www.nytimes.com/2016/10/17/business/international/china-home-price-bubble.html?_r=0

http://blogs.wsj.com/chinarealtime/2016/10/12/early-look-chinas-economy-appears-stable-but-watch-the-housing-bubble/

The BIS Warns of Record-High Banking Stress in China

The Bank for International Settlements has recently released a quarterly report warning that China’s “credit to GDP gap” has reached a record 30.1%, indicating that the world’s second-largest economy faces mounting debt and credit pressures. According to the BIS, levels elevated beyond 10% signal high banking strain in an economy. In the United States, for instance, readings surpassed the 10% threshold in the lead-up to the financial recession.

The elevated credit to GDP gap suggests excessive credit growth in China and the possibility of a financial implosion. Should such an event occur, the repercussions would greatly damage the global economy. According to the Telegraph, “outstanding loans have reached $28 trillion, as much as the commercial banking systems of the US and Japan combined. The scale is enough to threaten a worldwide shock if China ever loses control.”

China’s total debt has reached 255% of GDP, having ballooned by 107% in the past eight years, and continues to grow, while corporate debt alone has hit 171% of GDP. Though China’s leadership has promised to limit debt growth, it has been hardpressed to follow through on its pledge given that debt has sustained the nation’s economic growth. Government spending on infrastructure and real estate has also proven to be less productive and failed to contribute meaningfully to GDP.

Some analysts have taken to prescribing bank recapitalization and reducing reflexive stimulus spending to artificially sustain growth on the part of the Chinese government. China’s central bank issued a statement earlier this year averring that investors would be able to maintain reasonably high levels of capital in the event of a serious banking shock. The fear, according to the Telegraph, is that a surge in capital outflows may force the central bank to sell off foreign currency to bolster the yuan, “automatically tightening monetary policy” and sparking a vicious cycle.

Significant doubts remain as to whether the government can extricate the nation from its precarious situation, though state control of the financial system may conversely prove to partly mitigate the risk of a banking crisis.

References:

http://www.mauldineconomics.com/outsidethebox/does-it-matter-if-china-cleans-up-its-banks

http://www.bloomberg.com/news/articles/2016-09-18/bis-warning-indicator-for-china-banking-stress-climbs-to-record

http://www.telegraph.co.uk/business/2016/09/18/bis-flashes-red-alert-for-a-banking-crisis-in-china/

http://www.businessinsider.com.au/this-early-warning-indicator-of-looming-financial-risks-is-flashing-red-for-china-2016-9