Limited room for China to tighten policy as debt fear grows

[BEIJING] China's leadership is signalling growth will slow slightly in 2017, policy advisers say, as it struggles to strike a balance between supporting the economy with loose credit conditions and preventing a destabilising build-up in debt.

That means the interest rate easing cycle that began in November 2014 and saw six cuts by October 2015 is probably over, they say, particularly as investors are drawn to higher US interest rates and move money out of emerging markets including China.

China's economic growth is likely to be around 6.5 per cent next year, several sources said, the minimum needed until 2020 to meet goals of doubling GDP and per capita income from 2010 levels. This year's target is growth of 6.5 to 7 per cent.

The challenge is how to tighten credit to contain debt, speculative investment and outflows without triggering defaults and company failures, said the sources, who are involved in internal policy discussions and offer advice to policymakers but are not part of the final decision-making process.

"Policy cannot be too loose, but the room for policy tightening is not big. They need to support growth while pushing for deleveraging and preventing bubbles. This is a difficult balance," said one of the sources.

When top leaders met last week for their annual Central Economic Work Conference, the key pledges for 2017 were not about growth but dealing with asset bubbles and financial risks.

And the characterisation of monetary policy as "prudent and neutral", a change from "prudent", which had been used since 2011 through both tightening and easing cycles, could be significant.

"Policy could tilt towards slight tightening under the premise of 'prudent and neutral', but conditions for raising interest rates are not ripe," one source told Reuters, speaking on condition of anonymity.

The People's Bank of China (PBOC), which has been guiding money market rates steadily higher, is unlikely to raise benchmark interest rates before consumer inflation reaches 3 per cent, even though rising US rates will narrow China's yield differential, the advisers said.

Consumer inflation quickened to an annual 2.3 per cent in November and producer prices jumped 3.3 per cent from a year earlier, easing deflation concerns after factory-gate prices had fallen for five years.

The yuan has fallen to 8-1/2-year lows this year and is not far from weakening through 7 per US dollar, even as authorities have run down reserves by around US$280 billion so far in 2016 to support the currency.

It is expected to remain under pressure next year, given the outlook for interest rate increases by the US Federal Reserve.

That means the PBOC will remain reluctant to cut bank reserve requirement ratios (RRR), given that such a move could exacerbate pressures on the yuan, they said.

And with monetary options limited, the advisers said leaders may look to running a fiscal deficit of 3 per cent or higher to support the economy, similar to this year's target.

The economy is on track to grow around 6.7 per cent this year, the slowest in 26 years.

The economic growth target for 2017 won't be announced until early March next year, when they hold the annual parliament meeting.

Authorities could also tighten existing capital controls to limit outflows, the sources said, though draconian moves are unlikely because China still wants to push yuan internationalisation.

In recent months authorities have taken measures such as clamping down on illegal money transfers and increasing scrutiny on some outbound investment to try to stem outflows.

The PBOC and the State Council Information Office, the government's information arm, did not return requests for comment.

Two big political events next year - Donald Trump becoming US President in January and China's 19th Party Congress in the autumn - mean there will be a premium on economic stability, the advisers said.

In line with that, they think the government may set a growth target for broad money supply near 12 per cent.

That is a touch lower than this year's 13 per cent but still well above the economy's growth rate, a sign that growth will not fall sharply. But it also means there are limits to how hard policymakers will act to tackle the debt problems.

Corporate debt levels and property prices have soared this year due to rapid lending growth.

China's debt-to-gross domestic product ratio was 250 per cent at the end of 2015, according to the IMF, and with 11.6 trillion yuan (S$2.4 trillion) in loans issued so far this year and on course to beat last year's record 11.72 trillion, the rate looks set to rise again in 2016.

Outstanding loans, which excludes items including bonds and government borrowing, rose from 135 per cent of GDP in 2014 to 145 per cent last year, and looks set to surpass 150 per cent of GDP in 2016, according to Reuters calculations, despite a key goal for the year being to reduce leverage.

Jia Xiaojun, senior analyst at Industrial Securities, expects policymakers to start the year with an eye on controlling risks, but may need to loosen later in the year.

"(The government) won't tighten things up too much, otherwise the economy could take a big hit from financial stress, which I don't think they want," Mr Jia said.

REUTERS