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China on track to achieve 2017 growth target
AFTER three decades of China's almost unstoppable growth fuelled by rapid credit expansion, many China watchers believe that it is only a matter of time before a crisis hits the country. Their worst fears seemed to materialise in 2016 when capital outflow risks and debt problems surfaced and bogged down the Chinese economy. But the market re-accelerated in the first half of 2017 supported by the return of private investors' confidence and an improving global outlook.
NO IMMINENT DEBT CRISIS
So where does that leave China? Despite its recovery in the first half of the year, many are still holding their breaths especially after credit rating agency Moody's downgraded China's credit rating - its long-term local currency and foreign currency issuer ratings to A1 from Aa3 and changed the outlook to stable from negative - in May this year for the first time in 28 years, citing debt problems.
There is no easy solution to these problems. The downgrade sparked a debate in the market as it came at a time when the Chinese economy showed signs of recovery. Moody's call may have its merits as we do agree that there is no easy solution to China's debt problem. The high gearing levels prevalent in the corporate sector makes things particularly tricky. At an estimated level of 160 per cent as at 2016, which is practically unheard of in the current global context, China's high corporate leverage has always been a key argument for China bears.
However, a debt crisis in the next two years is unlikely due to China's unique debt structure.
A closer look at China's corporate debt reveals that more than 55 per cent of China's corporate debt was owed by state-owned enterprises (SOEs). The higher percentage of SOE debt gave China more room to manoeuvre as they could use different tools, such as debt-for-equity swaps, to handle the problems that surfaced in the past few years. This probably explains why China is still crisis-free at the current juncture despite unprecedented high corporate leverage.
Meanwhile, the recent two sets of data with regard to improving industrial profit and return of PPI to positive growth are encouraging. Both sets of data imply a better profit outlook for SOEs, which act as buffers to potential shocks from high corporate debt. This reinforces our view that a debt crisis should not be in our baseline scenario for the next two years.
KICKING THE CAN DOWN THE ROAD
Thanks to tighter capital control, China's foreign exchange (forex) reserves have risen for five consecutive months since this February. China's policymakers have demonstrated their power to keep the outflows in check without destroying foreign investors' confidence and disrupting the normal trade flows and economic growth via tightening the grip on overseas direct investment as well as portfolio investment.
Although these measures did not fundamentally solve the problems, it gave China time to stabilise its domestic market confidence and wait for the turn of global situation. China's "kicking the can down the road" strategy paid off after a correction in the US dollar following the unwinding of US President Donald Trump's reflation trade, which alleviated the depreciation pressure on the RMB.
In addition, The People's Bank of China's (PBOC) recent fine-tuning of the RMB-fixing mechanism to introduce the "counter-cyclical factor" also gave China more discretionary power to set the RMB's daily fixing to influence the market sentiment without derailing its currency reform agenda. The stable currency outlook is positive and will keep the cross-border flows relatively balanced. Thus, the probability of a capital outflow-induced crisis in the near term is very low.
SHORT-TERM VOLATILITY REMAINS
Having said that, China's near-term growth may still face volatility due to the tug of war between regulators and financial institutions on the question of financial deleverage. China launched a fresh round of financial deleverage at the beginning of 2017 after policymakers lowered their growth target to around 6.5 per cent. The stronger-than-expected on-balance sheet loan expansion was probably the result of China's deleverage efforts to curb the off-balance sheet and shadow banking activity, which may drive loan demand back to traditional channels.
Meanwhile, M2 growth decelerated to 9.6 per cent year on year, below 10 per cent for the first time in history. The lower M2 growth is likely to be the new normal going forward.
On a more positive note, despite strong commitment from China's policymakers on financial deleverage, the negative spillover effect from monetary and regulatory tightening policies has been largely balanced by the steady private sentiment and improving manufacturing outlook. Private investment remains stable, expanding by 6.8 per cent in the first five months while manufacturing production grew by 6.9 per cent year on year. In addition, fixed asset investment in manufacturing accelerated to 5.1 per cent in the first five months. The stable private investment, together with improving manufacturing activities, shows that the recent recovery is genuine and the momentum is likely to last longer than initially expected.
Overall, growth may have peaked in the first quarter and could slow down in the coming quarters due to higher funding costs as a result of monetary tightening, which may eventually be passed to the real economy. Though the delicate balancing act between deleverage and maintaining financial stability could still cause volatility, China is still likely to achieve its 2017 growth target of around 6.5 per cent and we have recently revised our 2017 GDP forecast for China to 6.5 per cent from 6.4 per cent previously. The world catches a cold when China sneezes, so this is good news for everyone.
- The writer is head of Greater China Research, OCBC Bank.