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 10-Year Sovereign Bond Yield Surges By Record Amount

Yields on Chinese 10-year sovereign bonds soared by a record 22 basis points on Thursday hitting a 16-month high of 3.4%, prompting authorities to halt trading in some futures contracts. 10-year and 5-year government-bond future prices plunged by a record 2% and 1.2% respectively in early trading, leading yields to soar.

The global market selloff was sparked by comments from the Fed signaling a vigorous clip of interest-rate increases for 2017 and a plummeting yuan. While Wednesday’s announcement that the Fed would raise the benchmark policy rate by 0.25% had been foreseen, its promise to introduce three more next year caught many off guard.  Other factors exacerbating the selloff include concerns of frothy asset markets, accelerating capital outflows, and a liquidity crunch.

“The market was not expecting a change,” said Mike Amey, a portfolio manager at Pacific Investment Management Co., regarding Fed’s announcement to the Wall Street Journal. “You can see that in the reaction in the market.”

The Chinese bond selloff is part of a global trend. US Treasuries have also declined amid expectations of interest rate hikes, adding negative pressure to the yuan and making Chinese bonds all the less attractive to investors.. Germany and Australian government bond yields have jumped by 0.062% and 0.2% respectively. UK yields, in contrast, declined slightly on the back of a Bank of England announcement that it would keep interest rates stable.

Bloomberg adds other factors that have reduced the appeal of debt. Both globally and in China, inflation is expected to accelerate, driving up consumer and producer prices. Moreover, the People’s Bank of China has been driving up money-market rates to spur deleveraging. In response, Chinese banks have begun deleveraging and selling off bond holdings as assets have become more expensive to fund. Bond yields, in turn, have been following money-market rates.

Overall, the short-term outlook on global economic growth has brightened since Trump’s election, given expectations of deregulation, lower taxes, and higher spending. This has also encouraged investors to move away from bonds.

References:

http://www.wsj.com/articles/china-halts-trading-in-key-bond-as-panicky-investors-sell-securities-1481803121

https://www.bloomberg.com/news/articles/2016-12-15/china-s-record-bull-run-in-bonds-is-giving-way-to-a-market-rout

http://www.wsj.com/articles/bond-rout-deepens-after-fed-rate-signals-1481794245

http://www.econotimes.com/Chinese-10-year-bonds-yields-highest-since-Nov-2015-post-Fed-hawkish-outlook-heading-towards-350-pct-mark-451758

 

US Stocks Slump On Weak Chinese Export Data

US stocks have slumped following worrying news out of China that its exports in September had fallen 10% year-on-year, marking the sharpest drop since February. Chinese imports also fell 1.9% in September, after rising 1.5% in August. The steep decline in exports was greater than forecast, intensifying long-standing concerns about the slowing growth of the world’s second-largest economy and reflecting weak global demand for goods, which, in turn, bodes ill for global economic growth.

“Weaker-than-expected Chinese trade readings have increased concerns that the pace of global growth will slow further,” said Dennis DeBusschere, a macro research analyst at Evercore ISI, to the Wall Street Journal.

The Dow Jones Industrial Average fell 45.26 points, or 0.25%, to 18098.94 points. The S&P 500 dropped 0.3%, or 6.63 points, to 2132.55, while the Nasdaq Composite Index fell 0.5%, or 25.69, to 5213.33.

Traders sought refuge in government bonds, the yen, and gold, as Treasuries rebounded from a four-month low. The yield on benchmark 10-year Treasuries fell 3 basis points, or 0.03%, to 1.739%, reflecting higher demand. According to Bloomberg, the US Treasury sold $12 billion of 30-year debt on Thursday. Conversely, raw materials and energy stocks fell out in anticipation of weakening demand.

The weak data coming out of China has precipitated some doubts as to whether the Fed will indeed raise interest rates by its December meeting, though the market-implied probability rate of such an eventuality is still 66%. The consensus among traders and investors is that the Fed will proceed with raising the interest rate, despite the news.

“It’s going to take some pretty lousy data to persuade the Fed to not raise rates,” said Art Hogan, of Wunderlich Securities to Bloomberg. “The Fed’s letting us know that December is something they have to be talked out of, not into.”

References:

http://www.wsj.com/articles/global-stocks-down-after-weak-china-export-data-lower-oil-1476344506

http://www.bloomberg.com/news/articles/2016-10-12/dollar-near-6-week-high-versus-yen-after-minutes-crude-declines

http://www.forbes.com/sites/timworstall/2016/10/13/china-export-fall-knocks-global-stock-markets-because-of-what-it-says-about-the-global-economy/#52b4b7c633aa

http://www.marketwatch.com/story/us-stocks-open-lower-following-china-trade-data-2016-10-13?siteid=bnbh

China’s Rapidly Aging Population Bodes Ill For Future Economic Growth

China’s rapidly aging population has been exerting pressure on the second-largest economy in the world, prompting the U.S. Federal Reserve to warn that China’s growth could decline sharply by 2030. As its population ages, China’s labor productivity has fallen driving a slowdown in economic growth. Furthermore, the growth rate of China’s working age population is worryingly forecasted to become negative by 2020. Instead, China is slated to become the world’s most aged population by 2030. By 2050, over 30% of its population will be comprised of senior citizens, aged 60 or older.

With the overwhelming majority of China’s current working age population already employed (~80%), economists believe that productivity growth, rather than employment growth holds the key to sustaining Chinese economic activity and health in the future. In response to these looming concerns about long-term economic growth, Chinese officials opted to overturn its longstanding one-child policy last year in order to alleviate China’s demographic woes.

“It’s a little too late, but it’s better now than later,” said Yanzhong Huang, senior fellow for global health at Council on Foreign Relations to the International Business Times. “If the policy is put in place immediately, it will only take effect 20 years from now, in terms of relieving the high-level of aging.”

Other possible measures to bolster aging labor forces are proposed in a 2010 working paper composed by Harvard’s Program on the Global Demography of Aging. Suggestions include raising the retirement age, encouraging higher savings, employing primary care providers for children, increasing employment of women, liberalizing immigration, and expanding education.

The Harvard researchers posit that the China’s best avenue for mitigating the effects of an aging labor force is to mobilize and leverage underutilized segments of its population, namely, the undereducated, underemployed, and women. The study’s authors argue that creating a large reserve labor force can “can lay to rest concerns that China will not have enough workers in the future to preserve the country’s impressive growth in GDP and in GDP per capita.”

References:

http://www.reuters.com/article/us-usa-fed-china-idUSBRE92P14T20130326

https://www.hsph.harvard.edu/program-on-the-global-demography-of-aging/WorkingPapers/2010/PGDA_WP_53.pdf

http://www.ibtimes.com/chinas-one-child-policy-change-will-take-decades-relieve-economic-pressures-aging-2161789

http://en.people.cn/90001/90776/90882/7137446.html

Chinese Economy Rebounds Following Stimulus

China has released its highly anticipated economic figures for the second quarter of 2016, which rose 6.7% compared to the year before, beating analysts’ expectations, albeit barely. The numbers suggest that the nation’s economy is slowing at a steady pace, even if Chinese economic data is notoriously unreliable.

The Chinese economy picked up steam last month, rebounding after a series of tumultuous months. Industrial output, for instance, accelerated to 6.3%. Government spending in on infrastructure also helped lift industrial activity, compensating for a steep decline in private investment, which once fueled the Chinese economy. According to the New York Times, private investment fell to 2.8% (down from 3.9% growth in the first five months) whereas government spending on fixed assets ballooned by 23.5% in the first half of the year.

Zhou Hao, a Commerzbank AG economist, tells the Wall Street Journal that the economic stability could dissuade the central bank from cutting interest rates and other drastic monetary easing measures.

On the other hand, the heavy role that government maneuvering and stimulus played in buoying growth figures has given other economists pause, raising misgivings about the long-term sustainability of the economy.

IHS Global Insight’s China economist Brian Jackson, for instance, posed questions about the veracity of the numbers as well as the implications of state-led economic growth.

“The first misgiving reflects concerns that the government is squeezing as much growth as plausible from relatively opaque sectors via accounting techniques. The second misgiving reflects concern that if the data is wholly accurate, then it implies a deepening shift towards state-led growth in both the secondary and tertiary sector, which raises major doubts about the long term productivity and thus sustainability of current economic activity,” Jackson added.

Also troubling is the question of whether state-backed infrastructure projects are generating economic value. A recent study by Oxford’s Said School of Business avers that low-quality infrastructure investments presents a sizeable risk to Chinese economic growth, going so far as to argue that over half of the infrastructure investments in China have destroyed rather than added value.

“Unless China shifts to fewer and higher-quality infrastructure investments the country is headed for an infrastructure-led national financial and economic crisis, which is likely to spread to the international economy,” comments Dr. Atif Ansar, one of the study’s authors.

References:

http://www.wsj.com/articles/chinas-economy-rebounds-with-help-from-government-spending-1473744662

http://www.nytimes.com/2016/07/15/business/international/china-gdp-economic-growth.html

http://www.cnbc.com/2016/07/14/china-q2-gdp-growth-slightly-beats-expectations-reuters.html

http://phys.org/news/2016-09-china-infrastructure-investments-threaten-economic.html