American protectionism, quicker pace of Fed rate rises pose biggest threats to China’s economy
The current recovery, led by industry, offers Beijing a rare opportunity to shift policies from supporting growth to managing risks
Macro news out of China has gone from strength to strength. Economic data for the first two months of this year have surprised candidly to the upside, indicating a carry-over of solid momentum from late last year.
Industrial sectors continued to spearhead the recovery, as the rebound in producer prices helped to improve corporate profitability and lift business sentiment. The latest People’s Bank of China entrepreneur confidence survey shows that the overall confidence level among industrial enterprises has risen to a two-year high. Not surprisingly then, private investment growth has picked up noticeably since the fourth quarter of last year.
What is also assisting this recovery is an accelerated execution of public-private partnership projects, which explains why infrastructure investment growth has quickened to above 20 per cent.
Besides investment, another key engine of the economy is the housing market. After a period of cooling off, the property market appears to be experiencing a second wind, with house sales and prices all reaccelerating in early 2017.
A deeper look at the data reveals a diverging picture, however. In contrast to the earlier phase of the market rebound, where first- and-second-tier cities led the rise, the current strength has come mostly from lower-tier cities. Part of this may be the normal trickle-through effect, as the lower-tier markets catch up to those of major cities. However, it’s likely the government’s differentiated housing policies also played a role, as support for de-stocking continued in lower-tier markets, while policies in top-tier cities have been focused on curbing price bubbles.
Besides the positive domestic news, external developments are also encouraging. For a start, export growth has picked up nicely in the first two months, thanks to recovering demand in developed economies and a weaker yuan. Export orders have risen to a two-year high, pointing to further strength to come.
In addition, confidence in the Chinese economy, combined with US dollar weakness, has resulted in a period of stability in the CNY/USD exchange rate. More importantly, China’s foreign exchange reserves returned to above US$3 trillion in February, thanks to a combination of capital control and the government’s moral suasion for corporates to repatriate offshore earnings.
All of these helped to generate, by our estimate, the first monthly capital inflows, of US$27 billion, since May 2014. While the pressure on the RMB cannot be reversed easily, these latest developments should nevertheless make market expectations for the yuan and capital flows more balanced.
For Beijing, the current stable macro environment has important policy implications: it offers the authorities a rare window of opportunity to shift policies from supporting growth to managing risks and correcting imbalances. Recent actions by various authorities suggest that shift is already underway.
First, the People’s Bank of China has signalled a clear intention to deleverage the financial system. To achieve that, the central bank has raised interbank interest rates twice, and is working with other regulators on a revamp of shadow banking rules to control off-balance-sheet activities of financial institutions. These moves are long-term positive for ensuring the health of the financial system, but in the short-run, they have pushed up market interest rates, tightened liquidity conditions, and are likely to dampen credit growth in the economy. Managing the risk of spillover will be key.
Second, housing policies could be tightened further in markets where existing restrictions have failed to arrest rapid price appreciation. Indeed, following the National People’s Congress (NPC), where policy makers reiterated their commitment to control property bubbles, a number of second-tier cities have announced additional measures to cool the markets. These measures should prove effective in generating a slowdown beyond the first quarter, although the pace of the slowdown, as manifested in the aggregate data, may be mitigated by lingering strength in lower-tier markets.
Finally, Premier Li Keqiang has signalled, at the NPC, a continuation of policies to reduce overcapacity, deleverage corporate debt and restructure state-owned enterprises. Even though the target settings on these reforms have not been very ambitious, with Xi’s power consolidation and near-term growth being less of a concern, the pace of reform should at least accelerate in the coming months.
In thinking of what may disrupt the current tranquil environment, we believe the risks are mainly from outside of China. Protectionism from the US and a faster policy normalisation by the Fed remain the most pressing risks facing the economy. On the former, however, we have seen some favourable developments lately including the recent visit by US Secretary of State Rex Tillerson to Beijing, and expectations that Xi and Trump may meet as early as April.
Greater communication between Beijing and Washington is clearly positive for preventing misunderstanding and managing differences, all of which should help to lower macro risks for both economies.
Aidan Yao is senior emerging Asia economist of AXA Investment Managers