Top leaders call for further easing & reforms to stabilise growth

The Political Bureau of the Communist Party of China (CPC) held a meeting last week regarding the country’s economic situation and policies, and laid down the guidelines for the government’s economic work in the next several months. Chairing the important meeting, President Xi Jinping urged serious attention to the economic slowdown pressure as well as the rollout of more easing measures and reforms to facilitate stable economic growth. At the meeting, top leaders also passed the coordinated Beijing-Tianjin-Hebei development plan to accelerate the integration of the three areas and to facilitate the industry transfer or relocation from Beijing to Tianjin and Hebei.

Still-heavy downward pressure on China economy. The 1Q15 economic performance was basically in line with government targets with the employment situation relatively stable. Yet, the overall economy still faces further downward pressure due to overseas demand shrinkage, multiple domestic negative factors and fledgling new growth spots.

Top policymakers said attention should be paid to the economic downward pressure and advanced adjustments and fine-tuning to policies should be stepped up in time to ensure growth within a proper range. Meanwhile, policymakers pledged at the meeting to accelerate the pace of reforms and opening-up to enhance the sustainability of economic development.

Increasingly proactive fiscal policy. The leaders called for a more proactive fiscal policy with increased public spending and further reduction in tax and fee burdens on enterprises.

We expect the central government to increase its public spending, especially that on some infrastructure projects including railway transport, urban underground pipe networks, oil & gas pipelines, shantytown renovation, new-generation telecom & information networks and industrial upgrades to stabilise economic growth. Meanwhile, authorities are likely to push forward tax reforms (value-added tax, VAT, to substitute business tax) in the service sectors and to cut tax further for small and micro-enterprises.

More effective transmission of monetary policy to real economy. The policymakers urged the adoption of a well-balanced prudent monetary policy and more effective policy transmission to the real economy.

Although the central bank has launched consecutive loosening policies, financing costs for enterprises remain relatively high, especially the real-term interest rates amid deflation, and financing supply has undergone noticeable shrinkage owing to rising credit risk aversion. We note that the weighted average ordinary loan rate remained at above 6% while the GDP deflator and producer price index (PPI) respectively shed 1.1% and 4.6% YoY in 1Q15. The 1Q15 social financing amount registered an 18.3% YoY decline, with off-balance-sheet financing down more than 75.4%. The interbank interest rate has seen sharper fluctuations amid the strength of the US dollar and the heavy pressure of renminbi depreciation and capital outflows. It is more difficult for the PBOC to maintain stable base money growth and interbank rates. The central bank has to use more new policy tools including short-term liquidity operation (SLO), standing lending facility (SLF), pledged supplementary lending (PSL) and medium-term lending facility (MLF) to increase base money supply and suppress interbank rates. The new liquidity management tools play the roles of filling the liquidity gap amid slumps in incremental forex purchases, but their influence on market interest rates is below government expectations. The PBOC has to make more aggressive moves including cuts of the required reserve ratio (RRR) and base rates to suppress interbank rates, reduce financing costs and prevent weak credit expansion as in a “liquidity trap”.

Further supportive policies and institutional reforms to boost investment and consumption growth. The Politburo emphasised the key role of investment and vowed to step up efforts to tap consumption potential to foster new growth spots. The policymakers also required various departments to optimise the market environment, facilitate inventory digestion and drive the healthy development of the housing market. Meanwhile, the top government body vowed to support industrial upgrading, steadily reduce obsolete production capacity and avoid systemic risks.

With the housing softening cycle and industrial overcapacity pressure, overall fixed asset investment (FAI) growth sharply decelerated to 13.5% YoY in 1Q15 from 17.6% in the same period last year. Some infrastructure investments, especially in railway transport and city public facilities, noticeably picked up amid the government’s supportive policies, but this cannot fully offset the negative effect on overall FAI from slowing property and industrial investments. In addition, the room for further rebounds in infrastructure investment has been restrained by the shrinkage in local government land-oriented financing and shadow fiscal system, as the land market continues to cool and the central government tightens regulations over local government debt.

According to the new budget law and related regulations, local governments are forbidden from borrowing through the previously-common opaque channels like financing vehicles, and all such local government financing vehicles should be restructured as enterprises independent from governments. Provincial-level governments will be allowed to issue bonds subject to a quota set by the State Council and approved by the NPC, while prefecture-level and county-level governments can borrow only through provincial governments. After the approval by the NPC and State Council, provincial governments are allowed to issue special bonds with relatively low interest rates amounting to RMB1trn this year to repay the existing “opaque” debts of relatively high rates. Yet, the funding amount for new project investment has dived this year compared to the previous few years, restraining the rebounding pace of local investment. We note that the YoY growth of approved local project investment decelerated from 20.1% in 2013 to 15.9% in 2014 and 13.5% in 1Q15.

We expect the central government to accelerate market-based reforms and deregulation in service and infrastructure sectors to attract private capital and investments.

Announcement of further SOE reforms and opening-up measures to boost private investors’ confidence. The Politburo pledged to push forward state-owned enterprise (SOE) reforms and continue to protect the property rights of private enterprises. Meanwhile, it vowed to maintain the current opening-up policies for foreign capital.

To accelerate coordinated and integrated development of Beijing, Tianjin and Hebei. At the meeting, top policymakers approved the Beijing-Tianjin-Hebei coordinated development plan to accelerated the integration of the three regions. The strategic plan aims to transfer functions not essential to Beijing’s status as the national capital from the city to its neighbouring areas and optimise its development mode. This adjustment of the region’s economic structure will create new growth poles and control Beijing’s population expansion. Priority will be given to traffic management, environmental protection, energy security and industrial upgrades. Public services will be improved and innovation encouraged, according to the Politburo statement. The top leaders requested to remove all institutional barriers to the strategy and to launch pilot programmes as soon as possible.

Loosening policies expected to boost infrastructure investment in short term but fail to reverse economic cycle in long term. The expected further loosening policies are likely to stimulate housing sales in a few large cities and boost infrastructure investment especially in the Beijing-Tianjin-Hebei region in the short term. However, the economy can hardly return to a sustainable up-cycle as most traditional sectors are expected to continue to soften while the contribution of new growth spots remains modest. For 2015E China GDP growth, we maintain our forecast of 6.7-6.9%.