Stimulus or reforms? Investors confused as Chinese leaders grapple with an L-shaped dilemma
Investors have been left scratching their heads as China’s policymakers send out mixed signals on the country’s future economic strategy ahead of a crucial reshuffle at the 19th National Congress due next November.
Last week the official People’s Daily quoted an “authoritative person” in a front-page story as saying China’s economy in the coming years would be “L-shaped”, suggesting a stabilisation following steep declines, rather than “U-shaped” or “V-shaped” trajectories indicating strong rebound after bottoming out.
That statement took the domestic market by surprise as most investors have been expecting a firm economic rebound. The gross domestic product (GDP) grew 6.7 per cent in the first quarter, beating market consensus, following aggressive liquidity injection, policy support for the property sector and greater infrastructure investment this year.
“The GDP growth rate has not yet bottomed out but we think China can tolerate a managed growth deceleration to a low 6 per cent something – a likely level for the bottom of the L – in the coming years, so long as the pace is gradual and does not spin out of control,” said Helen Zhu, head of Chinese equities at BlackRock.
“It is not the number, be it 6 per cent or 5 per cent, that matters the most, but the quality of growth,” she said, adding the Chinese authorities are trying to avoid systemic risks while pushing forward reforms such as reducing overcapacity and restructuring debts.
“The overarching theme this and next year is the political power reshuffle. Policymakers just want a stable macro environment so that they can spend more time on consolidating power,” said Macquarie analysts Larry Hu and Jerry Peng in a note issued on Monday. “‘L-shaped’ just means that the policy goal is growth stability with few downside or upside surprises.”
A senior analyst with a mainland brokerage said all the L-shape talk has been like a “blow on the head”, leaving many investors confused.
Just a few days ahead of the People’s Daily interview, the Wall Street Journal reported that China-based economists and analysts have been warned by securities regulators, media censors and other government officials against airing negative statements on the outlook for the Chinese economy.
“From the beginning of this year, there was a clear message top down to heat up the economy again by the familiar investment-driven measures while reforms seemed to have been set aside. But suddenly this People’s Daily story put the focus back on structural reforms,” he said.
“So what are they saying? No more new liquidity? Or, is the debt problem even worse than thought?”
The guessing game has been a damper for the markets. The Shanghai Composite Index fell by 3 per cent last week while trading volumes of shares both in China and Hong Kong dropped to multi-month lows. Commodity prices continued to correct, with steel prices falling 10 per cent as punters reversed expectations for more aggressive expansion in infrastructure and property construction.
But some analysts believe the seemingly dramatic change in tone from the central government is actually in line with the official policy.
Zhu of BlackRock said past reforms in China have rarely been linear. She quoted People’s Bank of China Governor Zhou Xiaochuan to explain the reform trajectory. “When you have an opportunity, or say a window, to unfold reform, you need to seize it quickly. But sometimes the window closes, and you cannot fight against it. You just have to put it aside and do something else,” Zhou wrote in an article in Chinese finance magazine Caixin in Februry.
“The government will deprioritise and reprioritise tasks accordingly,” Zhu said. “We believe the government will place greater focus in 2016 on supply-side reforms and select financial reforms like breaking implicit guarantees in the bond market, which are important but potentially negative for near-term growth. In addition, we will see these paired with acceleration of reforms that may also be favourable for near-term growth, such as tax cuts and energy price reform.”
For Macquarie’s Hu and Peng, the reasons behind the L-shape story is even more straightforward.
“Policymakers would swing between supply-side reform and demand-side stimulus. If growth faces downside risks like early this year, they would play demand-side stimulus by pumping more money into infrastructure investment…If growth stabilises, like now, they would then spend more time on supply-side reform such as cutting overcapacity and cleaning up bad loans,” they said in their note.