China’s Whispers, and the World Listens

Global financial markets are increasingly influenced by events in China. This is, perhaps, no surprise. Its emergence has been one of the main economic stories of the last 30 years – already it is the world’s second biggest economy.

But as its economy grows, China faces new challenges. Hence the increased global focus on policy and political developments in Beijing, at Tuesday’s opening day of the National People’s Congress. This annual two-week meeting is also termed “The Two Sessions” as it brings together the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference (CPPCC).

This meeting – and in particular President Xi’s speech during it – will provide the latest official thinking and direction of travel for the country.

Setting the scene

On the first day, Premier Li provided an insight into the latest economic backdrop and policy outlook. The main messaging made sense, and fitted with both recent policy behaviour in China and how the economy appears to be behaving.

It was also in line with the annual Central Economic Work Conference, which took place under President Xi last December. That is the major annual economic policy meeting and signalled prudent monetary policy, a proactive fiscal policy and further reforms, among other areas, for state owned firms, in market access and in tax and financing.

One of the takeaways from Tuesday’s speech was that the economy is slowing, not collapsing, as some in the market fear. Thus, the authorities are providing additional stimulus.

In addition, given recent trade tensions, and the need to address the concerns (perhaps misplaced, or otherwise) of international investors, there will be supply side reforms. This notably addresses the ‘competitive neutrality’ principle for the first time, so that firms will be treated the same wherever they come from.

Thus, one could say, the conversation was grounded in the three S’s: slowing, stimulus and supply side change.

How things have changed

Such an alliteration helps highlight how things have shifted since the start of last year. Then, at Davos 2018, Liu He, the senior economic spokesman, talked of the three P’s, a message repeated at the Two Sessions last March. Then it was about addressing pollution, alleviating poverty and a focus on prevention of risks, notably the need to deleverage the economy.

As last year progressed, however, the focus changed. The domestic economy slowed and appeared more vulnerable than the authorities would like, and, of course, trade tensions escalated with the US. In recent weeks, the news on the trade front has appeared more positive, as it makes economic sense for the US and China to resolve their concerns. Tuesday’s speech by Premier Li has to be seen in this changing context.

Last year China grew by 6.6%. The Premier talked of growth of between 6% and 6.5% this year. Such a range fitted with outside thinking before the conference. This is still a healthy growth rate.

To put this in perspective, last autumn the IMF’s figures put the size of the Chinese economy at $14.172 trillion (in nominal terms).

A 6.5% growth rate would see China grow by $921 billion, not far off the equivalent of adding an economy the size of The Netherlands, whose size is $952 billion. The Netherlands is the 17th largest economy in the world. Turkey, at $950 billion, is 18th. At a 6% growth rate China would grow by $850 billion, thus adding an economy bigger than Saudi Arabia, the 19th largest in the world, at $796 billion.

In a nutshell, China’s size means that even though it may be slowing, its scale is colossal.

Ensuring stability, but at a cost

The message from the Premier fitted with how the economy appears to be behaving and thus the stimulative policies proposed make sense. His message was, “Against the backdrop of mounting downward pressure on the economy, the policies and measures we adopt should ensure stable expectations, stable growth and structural adjustments ... to forestall and control risks, we need to get the pace and intensity right.”

The main focus is a fiscal boost. Given the worry that trade tensions will hit exports, the aim seemed to be to help manufacturing. The rate of VAT on manufacturing goods will fall from 16% to 13%. A VAT cut is a quick way to help spending and stimulate any economy, and is usually effective.

The VAT rate on construction is cut from 10% to 9%. The stimulus will total CNY 2 trillion (about $290 billion) and the budget deficit, which was 2.6% last year, is aimed at being 2.8% in 2019.

However, the broader budget deficit will be higher because there will also be a stimulus provided by allowing local governments to issue bonds to finance spending. This boost alone is worth CNY 2.15 trillion. In addition, the Premier said that monetary policy will be neither too tight, or too loose.

This does not mean they will not ease further, and we would expect them to, thus continuing the trend of recent months. But Li did state the currency would be stable. That is what one would have expected him to say, alleviating US worries, while also reflecting their policy desire too.

A focus on the world stage, too

In addition to easing taxes, and regulations for firms at home, the Chinese are seeking to address trade tensions, aimed at showing that foreign firms will not be discriminated against, with market access and protection of intellectual property rights being mentioned. Alleviating worries about intellectual property rights is an important part of addressing trade concerns while still attracting foreign direct investment.

The financial markets are likely to be reassured by what they heard. The Premier made clear China will "refrain from using a deluge of stimulus policies," so stimulus measures are not aimed at flooding the market with liquidity, thus trying not to reawaken previous worries about a build-up of debt.

Yet the reality is that the budget deficit is rising. Therefore, China’s bond market continues to grow in size and significance. Also, we should be under no illusion that they will not do more if needed, as the Premier stated, growth would also not be allowed to “slide below the reasonable range”.

Please remember that when investing your capital is at risk.

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