A visit to China: beyond excess credit

Less than a year later Chinese policy makers seem calm and measured compared with what transpired in Britain and the US. Meanwhile, more volatility looms in Europe with the referendum in Italy in December and elections in France next year.

"Chinese policy has always had a pragmatic soul – if a policy has unintended effects, why not change the policy?"
Richard Yetsenga, Chief Economist at ANZ

Is China’s calm only relative? In our view Chinese policy has always had a pragmatic soul – if a policy has unintended effects, why not change the policy? It’s an attitude becoming more valued now.

China also used to be one place to escape domestic politics. But the parlour game of trying to determine how President Trump will differ from Candidate Trump is in full swing in China as well.

For the moment though, the Chinese business sector interest is more restrained and curious rather than the feverish fascination in play globally. Trump's apparent trade commitments, for instance, are a puzzle to many -- why doesn't Trump like China?

CHINA’S ROLE

With uncertainty comes opportunity. Any US withdrawal from the region, either in the trade arena or diplomatically, potentially leaves space which could be filled.

Expect the Regional Comprehensive Economic Partnership to receive increasing air play if the Trans-Pacific Partnership is genuinely finished. And China has already signalled a willingness to lead on implementation of the Paris Climate Agreement.

The interest in outside politics is perennial but in the past commentary on the domestic front was muted. Raise domestic politics previously and mouths stayed closed and eyes roamed the high corners of the room. That’s changed. The shifts of recent times towards a more strongly centralised decision making structure has elevated domestic Chinese politics to a topic of intense interest.

As with China's history over the centuries, much can be understood by viewing President Xi’s elevation to Core-Leader status as a fundamental rebalance between the centre and the provinces.

That will play out in profound ways. Expect talk that Beijing’s policies are not being implemented at a local level to become increasingly scarce. Of course the very benefit of a more centralised system, particularly during a period of intense change in China's economy, is greater control of the provinces.

This shouldn’t be underestimated given provincial recalcitrance has often made capacity reductions difficult and given local government accounts for much of the questionably-financed state activity.

Domestic politics is not settled, so expect this to remain a feature of the discourse, but one can already discern the roadmap, and it will likely strengthen the red telephone-style of economic management.

THE ECONOMY

On the Chinese economy, domestic assessments, questions and risks have increasingly aligned with those externally. Questions about the quality of the macro data and excessive growth in credit are perennial.

China's growth performance this year, therefore, has been as much of a surprise domestically as it has to external observers. We have come away a little more comfortable with our view the economy will manage its secular adjustment in reasonable shape.

The capacity cuts in the state-dominated coal and steel sectors do seem to be real, certainly prices don’t spike like they have without some fundamental support, and it is still difficult to identify the catalysts for a serious nation-wide housing sector issue.

Growth in incomes is still very strong and prudential crackdowns on the purchase of multiple properties are becoming increasingly forensic (for example by examining household bills for couples who claim to have divorced).

As well, the hukou system of attachment to one’s home town, regardless of migration for work or other purposes, encourages empty dwellings, and is likely a key factor in China’s very high home ownership rate.

In the financial system, shadow banking activity has increasingly come into the formal sector. Prudential standards have improved. The yield on wealth management products has declined as opacity has fallen.

They now yield only around one percentage point more than government bonds. In early 2015 the gap was twice that.

There is still too much credit growth to be sure but knowing where it is going is an important step forward.

RMB

We shouldn't underestimate either the flexibility of China's economy or its ability to generate growth where established state-linked players don't already have a foothold.

Consider it is less than 18 months since last year’s 811 devaluation of the RMB. For companies the exchange rate has already taken over from interest rates as the main risk management task.

If anything there is something of an obsessive over-focus here and this was a concern in every discussion, suggesting the central bank is unlikely to allow genuinely unfettered currency volatility anytime soon.

Understanding that as the level of a country’s foreign exchange reserves becomes less important as currency flexibility increases will likely aid perceptions.

DIGITAL CHINA

Developments in the digital economy are also remarkable and seem to more advanced than almost anywhere else I visit. Following London’s original lead, Beijing has ranks of bikes available for public use.

These, however, are SIM-card and GPS enabled, can be booked remotely, and found and activated using your phone.

Every meeting is followed by a huddle as participants scan each other’s WeChat (a combination of LinkedIn, Facebook and even internet banking) QR codes in order to maintain contact.

Ali Pay is ubiquitous - in fact I was virtually the only person I saw using cash during my week-long visit. And Tao Bao or JD.com deliver anything (a pencil if you want), the next day, for free.

THE OUTLOOK

These factors suggest China’s challenges are likely to be manageable; not that they don’t exist. We can already discern a shift towards more stringent credit policy and that could well see China deliver the next leg of its secular growth slowdown next year.

Still, the global impact should be ameliorated by a stronger US economy and India's increasing role as a global growth driver.

How a (more) centralised political structure and established state players in many sectors will co-exist with an increasing need to allocate credit on commercial terms remains an open question.

Certainly we shouldn’t lose sight of these significant challenges. At the same time, we also shouldn’t lose sight of China’s successes or the flexibility of its economy – even compared with western countries. China’s expectations hurdle remains relatively modest.

Richard Yetsenga is Chief Economist at ANZ