These three major China themes will be pivotal in 2017
China’s economic growth target, the depreciation of the yuan and a looming change in several senior Communist Party positions will be important factors in the year ahead
After a turbulent 2015, 2016 turned out to be a decent year for the Chinese economy. Economic growth was steady at 6.7 per cent throughout the first three quarters and should print at similar levels in the fourth quarter, allowing Beijing to achieve this year’s target. In addition, the government has managed to make some progress on a number of structural reforms, such as reducing industrial overcapacity, restructuring the corporate sector and liberalising the financial market.
Against these achievements however, a number of old ills in the economy have deteriorated further. Chief among them is leverage, as credit growth continued to outstrip nominal GDP growth. Inefficiency of credit usage remains a deep concern as liquidity continued to be channelled by state-owned enterprises and into the property market. As a result, the overall debt-to-GDP ratio is expected to climb above 260 per cent by end-2016.
Externally, the focus on the yuan and capital outflows has been intense ever since the foreign exchange regime change last August. The recent strength in the US dollar has put pressure on China’s external account, prompting the authorities to tighten capital controls and step up forex intervention. The US dollar/yuan could break the psychological level of 7.0 by the year-end, if the dollar rally continues apace.
Looking ahead to 2017, three themes are worth pondering for China watchers – growth, yuan and politics.
On growth, Beijing reiterated its growth target of 6.5 per cent for 2017 at the Central Economic Work Conference earlier this month.
This will serve as a binding constraint for economic policies in a year of leadership transition, where macro stability will be valued dearly.
But maintaining steady growth may not be an easy task. Two engines of the economy this year have been the rebound of the property market and strong fiscal spending. One of them is, however, set to sputter in 2017, as recent policy tightening cools the property market. With stable consumption and exports unlikely to revive strongly, the burden of growth support may once again fall on the official-sponsored infrastructure investment.
This, however, will come at a time when financing for infrastructure projects is expected to tighten, because of higher fiscal deficit, reduced land sales and rising interest rates. Also, marginal returns of these projects have declined, as more and more has already been built. In light of these implicit/explicit constraints, the push for infrastructure spending may become more challenging in the year ahead.
One potential bright spot in the economy could be private-sector investment, which has bottomed after years of growth declines. Recovering producer prices expanding margins and improved demand have led to a recovery in business confidence and profitability, leading to more incentives to invest. If this trend continues, private investment – accounting for 65 per cent of total fixed asset investment – could play an important role in stabilising growth in 2017.
The main risk for macro stability lies in the external account. Like 2015 and 2016, the yuan will likely remain a key focus of the market, and the authorities will want to keep conditions stable ahead of the Party Congress in the autumn. Steady normalisation of foreign exchange value is what Beijing wants to see, but with a porous capital account and market expectations becoming fluid, engineering a steady depreciation path for the yuan will be challenging in light of a strong dollar. Something will have to give between preserving near-term stability and liberalising the capital account. We think that, when push comes to shove, stability preservation will take priority, meaning that more capital controls and forex intervention will be deployed in times of market jitters.
Finally, politics will likely remain at the centre stage for the global market in 2017. Any changes brought by German and French elections will matter for China, given that close to 20 per cent of Chinese exports are earmarked for the European market. In the US, even though the election has finished, significant uncertainties about Donald Trump’s policies remain. In relation to China, Trump is unlikely to implement, in full, his hostile policies promised during the campaign, but even a selective execution of those policies could impact the economy and move the market. Hence, politically-induced market volatility will likely remain elevated in 2017.
Internally in China, a once-in-a-five-year turn of the political cycle will be marked by next year’s 19th Communist Party’s Congress. This is an important event to watch for two reasons. First, a major reshuffle of the senior leadership of the Communist Party will take place, as five of seven Politburo Standing Committee members are due to retire. Such a change at the very top of Chinese politics could bring policy changes for the coming years. Second, China is at a critical juncture of its economic development, confronting both internal challenges and external pressures from rising protectionism and populism globally. How will China tackle these challenges, for instance by continuing to reform or retreating back to the old model, will be a key focus of the market. The Party Congress, and its subsequent Plenums, are important avenues for the senior leadership to share their thoughts and set policies – recall that it was the Third Plenum after the 18th Party Congress that the current leaders revealed the blue print for reforming the economy.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers