China in 2017: A year of consolidation
Hao Zhou, Analyst at Commerzbank
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- China’s economy performed better than expected in 2016.
- The property rally saved the day. Coming into 2017 there are clear warning signs regarding the overall state of the property market.
- There are justified concerns of a bubble developing.
- The Chinese authorities are aware of these issues; consequently the coming year is all about risk control.
- We expect a large focus upon macro prudential measures alongside flat interest rates and a weaker currency.
- In our view, USD-CNY can easily trade towards 7.15 by the end of 2017, with risks on the upside.
Growth stabilized due to the property rally...
Growth surprised the market to the upside in 2016, printing at 6.7% in the first three quarters of 2016, while at the beginning of this year many investors were concerned about a “hard landing” in China. The property market played a crucial role in boosting growth due to the relaxation of both monetary and property policies.
The stabilization in growth was not costless. There are clear concerns of a property bubble in China. Property prices reached a new record high in Q3 2016, led by the first-tier cities. Moreover, Chinese commercial banks significantly increased their exposure in the mortgage market – in the first three quarters of 2016, newly added mortgage loans accounted for 42.5% of total new loans, while it was only 25% from 2010-2015, highlighting the potential risks associated with the property market. The property frenzy has also encouraged massive speculation in the commodity market. For instance, onshore thermal coal prices doubled from June to November, and iron ore prices surged by more than 40% from October to mid-November.
Chinese authorities have become seriously concerned about asset bubbles and we believe that the overall policy orientation has turned to “risk control” since late September when the PBoC extended the tenor of reverse repos and the big Chinese cities tightened property policies. The change of policy stance implies that China is confident of delivering decent growth in 2017, but that it won’t come solely from the property sector. Against this backdrop, we think the overall policy tone will become less accommodative.
Growth will continue to moderate…
In the past few years, consumption has steadily contributed to overall growth, and we believe this trend will continue given that income growth is expected to remain resilient. As private investment remains sluggish, the state-owned enterprises (SOEs) accelerated their investment, on the back of strong fiscal spending, which bolstered growth. The extremely high investment growth from SOEs cannot last for long, especially as China will have to restrict credit growth to control asset bubbles and extreme leverage. As such, we believe that the investment growth is likely to further moderate in the coming years, adding downward pressure on economic growth.
China will allow further CNY weakness...
As China rebalances a weak currency is a vital component of ensuring robust external demand. With CNY weakening, China actually increased its market share in the global export market over the past two years. It’s not all good news though. The risk of a weaker currency is that we could see further capital outflows from China, especially as the USD appreciates. To hedge this risk, China’s capital control measures will not be loosened any time soon. In the meantime, China needs to intervene into the market in order to steer a “managed depreciation”. This managed FX regime is unsustainable as China’s FX reserves are not infinite. We don’t expect significant inflation increases China as China’s FX depreciation is likely to be modest.
Deleveraging – Hopes and reality…
China’s corporate debt is still growing significantly, albeit at a slower pace since early 2015. The debt overhang brings long-term costs to the economy; dampening efficiency, endangering financial stability and limiting the room of both monetary and fiscal policies for manoeuvre. At the end of the day, excessive debt and overcapacity could lead to a self-fulfilling downward spiral. As we have mentioned many times, this is one of the biggest risks facing China over the medium to long-term.
Putting it altogether…
China will likely experience a moderation in growth over the coming year. We expect growth will print around 6.5% for the year with CPI printing around 2%. The overall policy tone will be less accommodative than 2016 and we think PBoC will refrain from rate cuts. As long as China faces capital outflows, the central banks needs to use liquidity injection instruments, such as medium-term lending facility (MLF) to maintain balanced liquidity conditions. Notably, the outstanding volume of MLF was around 2.1 trn CNY by the end of October 2016, equivalent to 150bps of RRR cuts. In our view it makes sense to maintain a downside bias for China related assets in the coming year. We expect continued capital outflows from China combined with further CNY weakness, and we expect USD-CNY will reach 7.15 by end 2017.