Download Economic Insight:

Economic Insight:
Greater China
Welcome to ICAEW’s Economic Insight: Greater China,
a quarterly forecast for the region prepared specifically
for the finance profession. Produced by Cebr, ICAEW’s
partner and acknowledged experts in global economic
forecasting, it provides a unique perspective on the
prospects for China over the coming years. In addition
to mainland China, we look at the Hong Kong and
Macau Special Administrative Regions (SARs).
Quarterly briefing Q4 2015
In this issue of Economic Insight: Greater China, we
explore the connections between the events currently
shaping the world economy and economic performance
in Greater China. Given China’s size and importance,
these connections have causal links operating in two
directions. We discuss both − how global events impact
the outlook in China and also how recent developments
in China are affecting the global economy. Following on
from this, we reassess the risk of a hard landing in China
and present our latest forecasts for the Chinese economy.
Findings:
• The likelihood of a global recession has risen, with the
slowdown in China spreading panic to much of the
rest of the world economy. This time round, restoring
growth will be difficult given that central banks have
already exhausted their arsenal and the world has
not yet recovered fully from the wounds of the
financial crisis.
• A significant risk ahead is the monetary policy
tightening expected from the US Federal Reserve.
This has already led to a depletion of global foreign
currency reserves. Further reversals put Asian
economies at risk, particularly Hong Kong and
Thailand.
• China’s renminbi continues to ascend as it overtakes
Japan to become the world’s fourth-largest currency.
Inclusion in the IMF’s Special Drawing Right (SDR),
an international reserve asset, is expected to be one
of the key events of this year.
Despite recent alarm bells coming from the stock market,
we find that China’s economic rebalancing continues
apace. Demand for some commodities such as cement
or steel has taken a blow, but other sectors are growing.
The cinema market, for example, is booming and is
expected to become the world’s largest in the next three
years. Demand for soft commodities such as coffee and
gasoline is also on the rise.
We conclude that policymakers face significant
challenges in terms of deflating China’s credit stock, but
our baseline scenario is for a soft and managed landing.
BUSINESS WITH CONFIDENCE
icaew.com/economicinsight
Will policymakers be able to prevent
another recession?
The global economy has had to sail through rough
seas in 2015. Despite a promising start to the year for
the eurozone, with the European Central Bank’s (ECB)
quantitative easing (QE) programme providing some
boost, the region has failed to make a return to sustained
and robust growth. The economy has remained anaemic
with even the currency’s core economies, Germany and
France, struggling to expand. While an agreement has
been reached for a third bailout for Greece, the lack of
cooperation and loss of trust among eurozone member
states during negotiations has reignited fears over the
future of the common currency.
In the UK, the victory of the Conservative party in the
General Election that took place in the spring, eliminated
some concerns in the business community, but its
promised vote on UK membership of the EU raised others.
Policy uncertainty has become a major issue in the US,
with huge question marks over the timing of a Federal
Reserve interest rate rise. A rise, if it comes, risks triggering
capital outflows from a range of emerging markets.
China itself returned to the economic spotlight this
summer after posting a wave of weak economic data
and seeing its stock market correct sharply. Policymakers
responded quickly with expansionary measures which
have contained the damage somewhat, but fears remain
that a sharp slowdown in the world’s second-biggest
economy could kick off a significant global downturn.
This would be especially damaging now given the fragile
state of the global economy, with many countries still
recovering from the 2007/08 financial crisis.
Strong dollar impacts global currency reserves
One important realm of the global economy that has
been particularly active this year has been monetary
policy. In some respects, this is not really ‘new news’.
After all, monetary policy was the main lever employed by
policymakers to help their economies return to recovery
after the recession. Hints that this may be reversing –
at least by the US Federal Reserve – sparked panic in
emerging markets when the Central Bank decided to
start tapering its asset purchases back in December 2013.
This so-called ‘taper tantrum’ put significant pressure on
emerging markets’ Central Banks which began raising
interest rates to defend their currencies. In order to do
so, they had to gradually make use of their foreign
exchange reserves. As shown in Figure 1, the total level
of global foreign exchange reserves has been following
a downward trend since mid-2014.
It is important to note, however, that reserves do not
simply represent quantities of money: their value is also
determined by exchange rates. Figure 1 shows reserves
expressed in US dollar terms. This means that the higher
the value of the dollar, the lower the value of total
reserves reported. Conversely, a falling dollar would lift
the value of reserves.
The trend of a strengthening dollar throughout much of
2014 and 2015 partly explains the fall in reserves. One
important event of 2015 in this context was the ECB’s
decision to launch a QE programme. This put downward
pressure on the euro in relation to the US dollar and
icaew.com/economicinsight cebr.com
the pound sterling. Given the euro’s role as the secondmost important global reserve currency, this was a key
factor behind falls in the value of reserves in late 2014 when
investors and traders started pricing in the ECB’s hints of QE.
Several other central banks also loosened policy last year,
including many emerging markets such as India, Turkey,
Indonesia, Thailand and of course, China. The People’s
Bank of China (PBOC) took numerous steps to stimulate the
economy, including cuts in interest rates, cuts in the reserves
requirement ratio and the savings ratio as well as
a devaluation of the yuan.
Figure 1: Currency composition of official foreign
exchange reserves, global total, US$ trillions-equivalent
US$ trillion equivalent
14
12
10
8
6
4
2
0
2012 2012 2012 2013 2013 2013 2013 2014 2014 2014 2014 2015 2015
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Unspecified
US dollars
Pounds sterling
Japanese yen
Euros
Other currencies
Source: International Monetary Fund (IMF), Cebr analysis
FOCUS Impact of potential US rate hikes
on Hong Kong
Despite high expectations of a rate rise in September, the US
Federal Reserve kept monetary policy on hold. Part of the
reason behind this hesitation is the persisting trend of low
inflation, as well as concerns about the weakness of the global
economy. Rhetoric remains focused on building expectations
for a rate hike this year – the consensus is that it will come
in December 2015. A US rate rise, if it happens, could have
major implications for emerging markets, leading to capital
outflows and negatively impacting companies with US dollardenominated debts.
A recent study compiled by Bloomberg Economics examines
10 indicators of growth, inflation and financial risks in
emerging Asian markets, in order to assess the level
of vulnerability to a US rate hike.1 The results showed Hong
Kong at the top of the list as the economy most at risk.
This is because of a high level of leverage – domestic credit,
for example, stands at over 230% of GDP according to
the latest data for Q1 2015 from the Bank for International
Settlements. External debt is nearly twice as high. Excessive
demand for, and availability of, credit has led to sustained
positive trends in the Hong Kong equity and housing
markets. Despite the slowdown in the equivalent markets in
neighbouring mainland China this year, house prices in
Hong Kong have been trending upwards since 2012. The
HKFE Hang Seng Index remains above pre-crisis averages
despite a recent correction.
ECONOMIC INSIGHT – GRE ATER CHINA Q 4 2 015
Overall, Hong Kong is identified as an economy particularly
vulnerable to an interest rate rise in the US given its profile
as a mature and globally interconnected economy, and the
important role played by the financial sector.
The Bloomberg study further identifies Thailand as an
economy at significant risk given its high levels of private
credit and the profile of its property market, while the
Philippines and India are identified as being relatively
resilient when judged on the same metrics. Mainland
China, however, is not seen as particularly vulnerable given
its high level of foreign reserves, low levels of external
debt, and low levels of foreign-held public debt.
Still, overall, Asian countries are identified as being less
vulnerable today compared to the ‘taper tantrum’ period:
with lower inflation allowing room to keep rates low and
stronger current accounts, these economies now seem
better prepared to weather a US rate rise storm.
Renminbi rises to become world’s fourth
most used currency
It is notable that the renminbi is absent from the list of
the world’s most important reserve currencies presented
in Figure 1. The IMF recently reported that the renminbi’s
share of global reserves was about 1.1% (equivalent to
$120bn).2 This is lower than the Australian and Canadian
dollars, but above the Swiss franc’s global (specified)
reserves at 0.3%. This is puzzling at first sight, given
China’s economic importance. But the tides are shifting.
According to data from global payments provider SWIFT,
the renminbi is catching up significantly in terms of its
status as a world payments currency. In the past three
years alone, the renminbi overtook seven currencies to
rise from twelfth to fourth place in the ‘premier’ league
of global currencies.
As shown in Figure 2, this shift has recently picked up
strong momentum: the renminbi’s share of the global
total of customer-initiated and institutional payments3
has more than doubled between January 2014 and
August 2015, rising from 1.4% to 2.8%. This has been
at the expense of the euro, the pound sterling, and the
Australian dollar which have lost ground by 19%, 10%,
and 9% respectively.
Figure 2: Customer initiated and institutional
payments, top 10 currencies’ share of global total –
change between January 2014 and August 2015
CNY
HKD
USD
CHF
JPY
THB
CAD
AUD
GBP
Within Asia alone, between 2014 and 2015,4 the
renminbi has risen to become the number one currency
for payments sent to or received from China and Hong
Kong, overtaking the Hong Kong dollar. The Asia-Pacific
region generally represents the most important region in
terms of renminbi used for international payments sent to
and received from China and Hong Kong, with renminbi
users claiming a 39% share. The number of financial
institutions using renminbi for payments in the region
has climbed to 555 in August 2015 from 471 in the same
month last year. This compares to 379 in Europe, 118 in
the Americas and 52 across Africa and the Middle East.
Moreover, China is actively trying to promote the
renminbi’s use in international markets. As noted in the
last edition of this report, a key example in this respect is
the ambition to include the renminbi in the IMF’s currency
basket, the Special Drawing Right (SDR). This currently
consists of four currencies: the US dollar, the euro, pound
sterling, and the yen. For this to become reality, it is
important that China continues to liberalise and promote
transparency (of which its recent decision to report the
breakdown of its reserves to the IMF is a good example).
However, a point that is often missed is that SDR inclusion
is not a black and white issue: the weighting of the yuan
within the SDR is a topic that deserves equal merit given
the likelihood of its inclusion towards the end of this year.
In this respect, two criteria that determine the weight
come to mind: the importance of its exports and its role
as a reserve currency. China currently ranks high on the
former but low on the latter. One strategy to increase the
renminbi’s attractiveness as a reserve currency is through
keeping its value strong and stable.
SDR adoption not the only motivation for
renminbi strength
After a continuous verbal beating from China’s global
peers for intentionally keeping its currency weak to
support export competitiveness, the situation has
at last shown signs of change. In its 2015 Article IV
Consultation Mission to China, the IMF stated that ‘while
undervaluation of the renminbi was a major factor causing
the large imbalances in the past, our assessment now is
that the substantial real effective appreciation over the
past year has brought the exchange rate to a level that
is no longer undervalued’.5 This appreciation has mainly
been the product of central bank intervention, with
the People’s Bank of China drawing down its foreign
exchange reserves in order to keep the renminbi value
aloft. This was briefly interrupted when the Bank decided
to devalue the yuan in mid-August, a move that was
widely perceived as part of an effort to stimulate the
economy in the face of deteriorating market confidence.
Still, despite this recent blip, the renminbi’s value in
relation to the US dollar is higher than the averages
prevailing in the pre-financial crisis period. China’s foreign
exchange reserves have also fallen back − from a peak of
just under $4 trillion in June 2014, they have now declined
to $3.7 trillion.6
EUR
-20
0
20
40
60
80
Source: SWIFT Watch, Cebr analysis
icaew.com/economicinsight cebr.com
100
120 %
At first glance, the long-term strategy of currency
appreciation may seem puzzling as it harms the export
sector − one of China’s most important industries and
sources of employment. However, in recent years, trade
ECONOMIC INSIGHT – GRE ATER CHINA Q 4 2 015
has faded into the background as a source of demand
for the yuan. More and more of the investment flowing
into China has been motivated by speculation for further
appreciation. Apart from self-reinforcing the yuan’s
appreciation, these inflows also provide liquidity in the
banking system and hence push down borrowing costs.
With this in mind, allowing the yuan to drop risks a
reversal in this kind of investment, which in turn could
drain cash from the financial system.
Figure 3: CNY per US$
CNY per US$
8.5
8
7.5
Aug 2015: PBOC
devalues the yuan
7
6.5
6
2005
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Macrobond
In contrast, keeping the yuan strong will continue to lure
global capital into China’s stock and bond markets. It
will also help contain wage demands in the increasingly
important Services sector, by keeping import prices
down. Currency appreciation will support a continued
rebalancing of the Chinese economy away from exports
and investment towards consumer spending.
Looking ahead, we expect a gradual appreciation of
the renminbi to extend beyond the IMF SDR review,
which will determine renminbi inclusion in this currency
basket. However, this is not to say that SDR adoption
of the renminbi is guaranteed − a number of obstacles
remain. The key criterion that the renminbi fails to meet
is that of full convertibility, given the restrictions that are
still in place in China’s capital markets. In that respect,
efforts to open up the capital account and deepen
financial markets should help the renminbi to become
a stronger candidate. While the IMF can also decide to
change its rules for inclusion into the SDR, this would
require a 70% to 85% majority ruling by the 24-member
executive board.
China’s rebalancing – is it still happening?
The downturn in China’s economy which shook the
world this year, has dominated China-related global
headlines. The need to prevent a ‘hard landing’
has become more prominent in the news than any
discussion of the longer-term need to rebalance the
economy away from investment and towards
consumer spending.
It is interesting to observe what is happening in China
as far as rebalancing is concerned. This Economic Insight
report series has continuously observed, documented,
and discussed the slowdown in China’s export and
investment sectors. We have argued that the slowdown
in these sectors, and its effect of dragging down China’s
overall economic performance, is neither a reason for
concern nor conclusive proof that China’s economy
is heading for a hard landing. On the contrary, it is a
natural ‘bump in the road’ of China’s transition to a
more consumer-oriented economy.
icaew.com/economicinsight cebr.com
Given the importance of these sectors in China’s
economy (exports, for example, still make up around a
quarter of GDP and investment makes up 44% of GDP)
commentators can be partly forgiven for focusing on these
sectors to draw conclusions about China’s economy and
consequently worrying over a Chinese crash. However,
it is important that China is understood as an economy
in transition. In this respect, it is interesting to observe
what has been happening not only in the export- and
manufacturing-intensive sectors of the economy in the
past year, but also the consumer- and domestic demanddriven sectors.
The data on the increasingly important consumer sector
are mixed at present. Burberry, the British luxury fashion
house, saw its shares fall by 8% in mid-October 2015 after
reporting a fall in revenue in Asia. Even though group
revenue stayed flat in the first half of 2015, there was a
dip in sales in China and the company stated that trading
there was becoming ‘increasingly challenging’.7 Macau,
which depends heavily on the leisure and tourism industry,
has also been heavily hit by similar challenges. Gross
revenue in the island’s gaming industry has been declining
at an average pace of 35% year on year over the first
nine months of this year. In February alone, an important
month given the Chinese New Year, gaming sales fell by
almost 50% compared to the year before.
Yet, despite these dismal statistics that make big headlines,
other indicators suggest that the middle class in China is
steadily emerging, setting the ground for a rebalancing
towards a consumer-driven economy. An interesting
example in this respect is the cinema industry. Although
this is a small part of any economy, it serves as a good
indicator for the health of the consumer market and for
the growth of the middle class. According to data from
the State Administration of Press, Publication, Radio, Film
and Television, as of September 2015 China’s box office for
that year had already exceeded the 2014 total of 29.6bn
yuan ($4.6bn) with a total of 30bn yuan ($4.7bn).8 This
represents a 48.5% growth compared to the same period
a year ago. In July alone, the box office totalled 5.5bn
yuan, more than the whole of 2008. Forecasts see the
Chinese box office, already the second largest globally,
overtaking North America within the next three years.9
Figure 4: Box office markets for global top 10 in 2014,
in current US$ bn
10.4
US/Canada
4.8
China
Japan
2.0
France
1.8
India
1.7
UK
1.7
South Korea
1.6
Germany
1.3
Russia
1.2
Australia
1.1
Mexico
0.9
0
2
4
6
8
10
12
US$ bn
Source: Motion Picture Association of America, Cebr analysis
ECONOMIC INSIGHT – GRE ATER CHINA Q 4 2 015
Oil and commodity prices in 2015 –
what can we learn from China?
Mainland China to continue cooling, with
negative impacts on Hong Kong and Macau
Another key event of 2015, and one that can be traced
closely to China, has been the persistence of low oil and
commodity prices. In September, Brent traded at $47 a
barrel – roughly the same price level as in January and less
than half the $95 per barrel average price in September 2014.
Forward-looking indicators suggest that the economy of
mainland China is slowing down. Recent data for Q3 2015
confirm this with annual growth coming in at 6.9%, the
lowest seen in six years. We expect that by the end of this
year, the economy will be shown to have expanded by
6.8% – impressive for advanced economies but low
for China compared to the recent past. Looking ahead,
a dilemma emerges: policymakers have to tread a fine
line keeping growth and employment levels afloat while
at the same time managing the transition towards a more
mature economy with a greater role for the services and
domestic consumption. If policymakers broadly focus on
rebalancing over short-term growth, we expect to see a
sharper slowdown in the short term with growth stabilising
close to 5-6% towards the end of the decade. This is
the recommended scenario, which we call ‘fast landing’.
However, it is possible that policymakers may fall for the
temptation of sustaining high growth rates now by easing
policy and providing credit – something that would be
unsustainable for the long term. We call this scenario ‘slow
landing’, as it delays the necessary and inevitable slowdown
further into the future. This scenario is far from desirable
as it is a case of avoiding short-term pain but taking away
from the potential for long-term gain. In this scenario, we
expect growth to slow more sharply in the medium term,
with even a recession on the cards within the next decade.
The chances for this would rise significantly if China’s credit
bubble is fuelled so much that it explodes, rather than
being helped to gradually deflate. A combination of supply- and demand-side factors have
contributed to this trend: on the supply side, American shale
extractors, record production in regions such as Iraq, and the
lifting of international sanctions against Iran are all positively
boosting supply, now and for the foreseeable future. On
the demand side, China’s industrial slowdown is curbing
demand for oil and other commodities. The downward price
pressures from reduced demand and increased supply are
further reinforced by a strengthening dollar, given that oil
and commodities are usually priced in dollars.
Figure 5: China’s commodity demand, 2015 year to date
vs same period in 2014, annual % change
Kerosene
Gasoline
Aluminium
Soybean
Coffee
Copper
Oil (total)
Zinc
Sugar
Cotton
Diesel
Corn
Steel
Wheat
Coal
Cement
-10
-5
0
5
10
15
20
25 %
Annual % change
Source: JODI, OPEC, USDA, RUSAL, WSA, Cebr analysis
Many have rushed to proclaim China’s declining demand for
commodities as yet another piece of evidence in building
the case for a hard landing. However, a closer observation of
China’s patterns of commodity consumption reveals some
rather interesting conclusions. As shown in Figure 5, not all of
China’s demand for commodities is in decline. In particular,
we notice an important distinction between so-called
‘CapEx’ and ‘OpEx’ commodities.10 The former category
includes commodities such as iron ore or cement, which are
heavy inputs for construction and other infrastructure. High
demand for such commodities acts as a signal that a country
is going through a period of industrialisation. These were
the commodities at the forefront during the years of China’s
demand-fuelled market boom. But now demand for such
commodities is slumping. Demand for cement, for example,
declined by 5.8% year on year in Q2 2015, compared to
4.4% growth seen in the same period a year ago.
The latter category presents a more positive picture.
China’s demand for the ‘operational expenditure’ type of
commodities, such as gasoline and coffee, is soaring. This
suggests that behind the scenes and the dismal headlines,
China is nurturing a growing middle class that is starting to
spend more on things such as food and personal travel.
As mentioned earlier, it is important that China is understood
as an economy in transition. The way China is consuming
commodities further reinforces our conclusion that the
country’s enormous economic transition is continuing,
not faltering.
icaew.com/economicinsight cebr.com
Hong Kong is expected to be negatively impacted by
the vagaries of the international economy in 2015 and
beyond. While the slowdown in mainland China itself is not
expected to be the main driver, a rate hike in the US (Cebr
forecast for 2016) is expected to take a toll on Hong Kong’s
financial services industry. We expect to see growth of
below 2% prevailing throughout the forecast horizon
(See Figure 6).
Macau’s leisure and tourism industry has already taken a
heavy toll from efforts in the mainland to contain
corruption. This is expected to drag growth down this year
with the economy contracting by 17%. Further ahead we
expect to see a modest return to expansion supported by
the growing middle class in mainland China. This should be
bolstered by the opening of the Hong Kong-Zhuhai-Macau
bridge. The annual pace of growth is expected to accelerate
to about 5% by 2017.
Figure 6: Greater China GDP growth forecasts,
annual % change
%
10
5
0
-5
Mainland China
(fast landing)
Mainland China
(slow landing)
Hong Kong
Macau
-10
-15
-20
2015
2016
2017
Source: Cebr forecasts
ECONOMIC INSIGHT – GRE ATER CHINA Q 4 2 015
ENDNOTES
1Source: http://www.ejinsight.com/20150528-hong-kong-seen-hardest-hit-by-us-rate-hikes/
2Source: http://www.imf.org/external/np/pp/eng/2015/071615.pdf
3 Messages exchanged on SWIFT; based on value.
4 This change is noted when comparing payments over Jan-Aug 2014 and those over Jan-Aug 2015.
5Source: https://www.imf.org/external/pubs/ft/scr/2015/cr15234.pdf
6 Latest data are for June 2015.
7Source: http://www.bbc.co.uk/news/business-34536578
8Source: http://news.xinhuanet.com/english/2015-09/08/c_134602012.htm
9Source: http://www.hollywoodreporter.com/news/china-box-office-exceeds-2014-820883
10 CapEx is short for ‘Capital Expenditure’. OpEx is short for ‘Operational Expenditure’. Source: Goldman Sachs
For enquiries or additional information, please contact:
Juni Ngai, Director, Hong Kong
T +852 2287 7277 / 6381 1687
E [email protected]
Cebr
The Centre for Economics and Business Research is an independent consultancy with
a reputation for sound business advice based on thorough and insightful analysis.
Since 1993 Cebr has been at the forefront of business and public interest research.
They provide analysis, forecasts and strategic advice to major multinational companies,
financial institutions, government departments and trade bodies.
ICAEW is a world leading professional membership organisation that promotes,
develops and supports over 144,000 chartered accountants worldwide. We provide
qualifications and professional development, share our knowledge, insight and
technical expertise, and protect the quality and integrity of the accountancy and
finance profession.
As leaders in accountancy, finance and business our members have the knowledge,
skills and commitment to maintain the highest professional standards and integrity.
Together we contribute to the success of individuals, organisations, communities
and economies around the world.
Because of us, people can do business with confidence.
ICAEW is a founder member of Chartered Accountants Worldwide and
the Global Accounting Alliance.
www.charteredaccountantsworldwide.com
www.globalaccountingalliance.com
ICAEW Greater China
Room 1103, Tower C1,
Oriental Plaza,
No. 1 East Chang An Avenue
Beijing 100738, China
icaew.com/china
ICAEW
Chartered Accountants’ Hall
Moorgate Place
London
EC2R 6EA UK
icaew.com
© ICAEW 2015 MKTDIGI14550 11/15