Download ECONOMIC INSIGHT GREATER CHINA Quarterly briefing Q2 2013

ECONOMIC INSIGHT
GREATER CHINA
Quarterly briefing Q2 2013
WITH SLOWING GROWTH CHINA IS IN
GOOD COMPANY
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 also focus on the Hong Kong and
Macau Special Administrative Regions.
Globalisation is taking a breather. World trade growth
has been at the lowest level since the late 1990s, if we
exclude the dotcom recession and the global financial
crisis. A major reason for this is the eurozone’s drawnout recession that is likely to stay through 2013. Another
factor is an apparent slowing of the US labour market
following the sequestration of public spending. Japan
has taken steps to overcome its long-term stagnation
with aggressive monetary policy, but it’s doubtful if this
will resolve the country’s fundamental problems.
Key emerging markets have also suffered a growth
slump. Russia is the latest of the BRICS economies to
come off a fast growth trajectory, joining India, Brazil
and South Africa. Global growth thus continues to be
muted, resulting in a drop in commodity prices from
their elevated levels. Better harvests are bearing down
on agricultural goods prices and new supplies of mineral
resources are contributing to a price fall in products
such as metals and petrochemicals. The deceleration of
China’s economy has played an important part in this
price decline. We now take a closer look at the reduction
in growth.
BUSINESS WITH CONFIDENCE
icaew.com/economicinsight
Investment props up growth
A soft landing appears to be in progress in China. Figure
1 neatly illustrates the gradual downwards trajectory of
key indicators. Most importantly, industrial production
growth is decelerating. However, fixed asset investment,
the motor of the Chinese economy, was still forging
ahead at an impressive rate of 26.5% year-on-year
growth, but that is 5.2 percentage points lower than
the figure in early 2010. It should be noted, of course,
that 2010 was a year of strong growth following the
dislocations of the financial crisis. China’s manufacturing
base faces substantial wage increases and trading
partners wounded by the aftermath of the Great
Recession are not ramping up purchases as before.
On the consumer side a steady reduction in the pace of
retail sales growth has been evident. Sales, which are not
inflation-adjusted, were 12.4% higher in Q1 2013 than
a year earlier, compared with annual growth of 23.7%
in early 2010. The reduction comes despite the above
mentioned rise in gross wages and suggests that the
much-vaunted turn towards consumption-led growth is
at best in its infancy. Another pointer in that direction
is the remarkable stability of investment in fixed assets,
such as machinery and equipment or buildings. Growing
at a faster rate than GDP, investment is propping up
growth and helped the economy to expand by 7.7%
year on year in the first three months of this year. The
following section explores where the capital for the
rising amount of investment comes from.
Figure 1: Annual growth rates of nominal GDP, urban
investment in fixed assets, retail sales and industrial
value added
This elementary fact becomes interesting when we
consider the huge amount of money saved in China each
year. Figure 2 shows just how big the cash pile is: with its
US$ equivalent of $4.1 trillion in 2012, China accounted
for almost one in every four dollars saved around the
globe (23.7%). That share has risen about four-fold since
2000, testament to the astonishing wealth creation
that has occurred here. By comparison, China’s share of
global output rose from 3.7% in 2000 to 11.5% in 2012
(at market exchange rates). That surge is changing the
world and it owes much to the growing abundance of
resources squirreled away each year.
Savings are calculated here as the amount of national
output that is not consumed by households, firms
or the government. The public sector runs a budget
deficit, meaning that companies and consumers
accumulate the savings. Though declared profits are
often low for tax reasons, the business sector plays
a big role in the accumulation of wealth. Managers,
some with government connections, may gain from
retaining earnings amid weak corporate governance.
Recent moves to raise dividend pay-outs of state-owned
enterprises look like an attempt to curb such tendencies.
Households also have good reasons to add to their nest
eggs, namely the need to provide funds for retirement in
a fast-aging population and a limited social safety net.
Figure 2: Chinese savings and value added as share of
world total at market prices
%
25
20
15
%
40
10
30
5
0
20
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Savings share
10
GDP share
Source: IMF, Cebr
0
Q1
Q2
2010
Real
GDP
Q3
Q4
Q1
Q2
Q3
2011
Industrial
production
Q4
Q1
Q2
Q3
Q4
2012
Fixed asset
investment
Q1
2013
Retail
sales
Source: China National Bureau of Statistics
Huge savings push investment
First-year economics students learn that savings must
equal investment when there’s no money crossing the
border. Of course, China has been a major beneficiary
of foreign investment, both in terms of capital and
of technology. Within the constraints of its industrial
policy regime, the country is open to foreign business,
but local funds don’t travel so easily. A closed capital
account means that neither firms nor individuals can just
invest money abroad – most of the resources stay in the
country and get invested in China. That may change as
the country’s firms enlarge their global footprint, but
that process will take years and for now most money
gets recycled into new housing, infrastructure or
productive capacity.
icaew.com/economicinsight
cebr.com
China’s credit surge continues
In practice, the straightforward theoretical relationship
between savings and investment is anything but simple
or direct. Transforming savings is the task of capital
markets and the banking system and China is no
exception. Most importantly, banks and other monetary
financial institutions take short-term deposits and
convert them into long-term loans. The stock and bond
markets are the other two major parts of the financial
system that make capital out of savings.
In 2012, CNY15.8 trillion passed through the system
and Figure 3 indicates the extent of growth in financial
intermediation. In the decade from 2002 to 2012,
the nominal value of capital annually dispensed by
the financial system went up nearly eight times. The
largest increase happened during the financial crisis:
the amount of money provided doubled when the
government ordered banks to open the credit taps all
the way.
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 013
Bank loans are a major tool of Chinese economic policy
that can be seen as a form of monetary stimulus. The
predominantly state-owned banking sector provided
money at low interest rates, often to state-owned
companies or to local government projects. The money
was used for investment, explaining why China was able
to keep cash flowing while the rest of the world saw its
financial system teeter on the verge of collapse.
The numbers given here are for ‘social financing’, a
broad term that includes equity raisings and other forms.
The next section takes a closer look at non-bank-loan
financing, which is becoming increasingly important. A
rising share of social financing in output is a mirror image
of the rising investment share of GDP that many consider
excessive. Since 2002, social finance has grown from
16.7% of GDP to 30.3%. The current level is higher than
during the credit splurge of 2009 and 2010, but its size in
relation to overall output has fallen.
Figure 3: Change in social financing and social
financing as a share of nominal GDP (%)
CNY
20,000
%
50
Non-loans
Social financing/GDP
Loans
15,000
40
10,000
30
5,000
20
0
10
Source: China National Bureau of Statistics
New forms of lending are taking hold
China’s economy is diversifying at an impressive pace,
moving up the value chain at a probably unmatched pace
and scale. As the industrial structure is becoming more
complex, financial services are racing to keep up with the
times. Financial liberalisation is proceeding steadily, albeit
at a measured pace. Regulation of the demand for and
supply of financial services is moving towards the creation
of a modern financial industry, with Shanghai as the main
onshore centre.
The diversification of financing options is evident in the
make-up of social financing exhibited in Figure 4. In
2002, the bulk of credit came from renminbi bank loans
that accounted for 91.9% of the total. Figure 4 gives
an indication of the magnitude of social financing over
time. This item had shrunk to 52.0% by 2012. One of
the reasons that forms of finance other than bank loans
are proliferating is that banks offer paltry returns to
depositors. Interest rate caps mean that real returns on
deposits are negative, pushing those with money to invest
into other products. The recent proliferation of wealth
management products that offer a higher rate of return
has allowed new players to gain market share. Loans by
trusts are a growth area in this regard, providing 8.2%
of financing. The bond market had become the second
largest means to raise funds, providing 14.3% of funds
now compared with just 1.8% back in 2002.
icaew.com/economicinsight
cebr.com
Figure 4: Composition of social financing
2002 2012
%
%
Non-financial institutions equity financing
3.1
1.6
Loans in foreign currencies
3.6
5.8
Loans in local currency
91.9
52.0
Bank’s acceptance bills
-3.5
6.7
Entrusted loans
0.9
8.1
Trust loans
0.0
8.2
Corporate bonds net financing
1.8
14.3
Source: People’s Bank of China
Do artificial transactions evade capital
controls?
Financial repression, the distortion of market mechanisms
with a policy purpose, reigns in China’s financial sector.
Capital controls, interest rate ceilings, state-directed
lending and restrictive market entry requirements
combine to give the government a large degree of control
over the capital market. In China, financial repression is
mainly exercised via two restrictions. The first is capital
controls that force firms and households to keep their
money in the country rather than moving it abroad.
Therefore, savings can be used to grow the capital stock
of the domestic economy without regard for the profit
outlook.
Secondly, interest rate ceilings keep borrowing costs
for banks low and guarantee profits due to consistently
higher lending rates. The two measures combine to
provide large amounts of cheap money for industry.
China’s foreign exchange policy of keeping the value of
the renminbi low is another weapon in the economic
policy armoury. A low exchange rate brings in export
revenues, helping producers make profits in the global
market. What is good for sellers is bad for buyers.
Households end up paying more for their purchases
produced abroad or featuring internationally traded
inputs.
Figure 5: Reported trade from China to Hong Kong
USD
50
40
30
20
10
0
1993
1998
2003
China exports to Hong Kong
2008
2013
Hong Kong imports from China
Source: Hong Kong Census & Statistics Department
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 013
The purpose of the system has been to provide funds
for industrialisation, with astonishing success. However,
capital market distortions provide incentives to circumvent
them as profit can be made doing so. Trade data provide
an indication that money is moving across borders to
circumvent currency controls. As Figure 5 shows, China
reports much higher exports to Hong Kong than Hong
Kong registers in imports from the Mainland. In other
words, goods are being sold but never get delivered. The
transaction is paid nonetheless, moving money to China,
presumably to avoid declaring its purpose. It would seem
that virtual trade in the other direction – moving money
out of the Mainland – would be more obvious, but the
figures imply this direction.
Growth to slow across Greater China
in 2013
Hong Kong’s economy is focused on
the Mainland
Meanwhile, quickly rising wages should provide a solid
basis for consumption growth and in the absence of a
global economic slump, export growth (excluding the
Hong Kong effect discussed previously) is expected to pick
up. Nevertheless, the large size of the economy means
that further income gains will be harder to achieve and
a shrinking workforce will further exacerbate the growth
decline. For 2013, the annual rise in GDP is expected to
fall to 7.4%, followed by a further deceleration to 7.2% in
2014 and 7.0% in 2015.
The use of trade transactions to shift funds between
Mainland China and Hong Kong would make sense as
the two economies are closely interwoven both in the
financial and the trade sector. The single largest industry
in Hong Kong is the import and export trade. Much
of this is based on close business relationships with
manufacturers in the Pearl River Delta across the border,
but exporters to China also use Hong Kong as a base. In
addition to the need for capital equipment to produce
China’s industrial output, the rising might of the Chinese
consumer is pushing this sector. Overall, more than a fifth
of Hong Kong’s economy is based on this trade.
The public sector is the second-largest part of the
economy with 16.5% of value added produced there.
That is a fairly small proportion by international standards,
reflecting the Special Administrative Zone’s history of
laissez-faire governance. Finance follows closely behind
and represents the other key industry that is linked to
%
China.
Providing 16.1% of Hong Kong’s value added,
OtherChina,
sectors but also a
it 100
provides a basis for investment into
services
platform for Chinese firms lookingOther
to go
abroad.
80
Construction
The third sector, which actually consists of property
Real estate services & ownership
60
services
as well as income from property ownership,
accounts for 21.5% of output. Adding
the
3.4% of the
Financial
sector
40
construction sector, almost a quarter of Hong Kong’s
Public sector
economy
is based on real estate. This, too, is influenced
20
by the Mainland as many rich people
have
snapped
Import
& export
trade
up properties
in Hong Kong, driving up prices but also
0
providing income to the sector.
Figure 6: Hong Kong sector contributions to value
added, 2011
Other sectors 3.5%
Other services 17.9%
Construction 3.4%
Real estate services & ownership 21.5%
Financial sector 16.1%
Public sector 16.5%
Import & export trade 21.1%
Source: Hong Kong Census & Statistics Department
icaew.com/economicinsight
cebr.com
Turning now to our regular economic growth projections
for the People’s Republic and its Special Administrative
Regions (SARs), the economy of Mainland China has
been slowing as we have described above. Investment
continues to drive the economy and the risk of a credit
boom turning into a credit bust is heightened by the
increasing prevalence of non-bank financing that isn’t as
amenable to mandated lending as the state-owned banks.
While it seems highly possible that the credit flood may
turn into a drought, the system of financial repression
should ease this risk and allow the country to manage the
inevitable rise in bad loans festering in the system.
Figure 7: Greater China GDP growth forecasts
%
10
8
6
4
2
0
Mainland
Hong Kong
2013
2014
Macao
2015
Source: Cebr
Limited world growth is affecting Hong Kong’s import/
export sector due to its position as the world’s busiest
port. In addition, curbs on property transactions should
temper activity in an important sector for the economy.
Still, output should expand at a faster rate than last year
as government provides stimulus and trade picks up
towards the end of 2013, bringing GDP growth to about
2.9% this year. For 2014, a rebound to 4.0% is projected
as globalisation gathers pace again, moderating to about
3.7% in 2015.
As Hong Kong relies on the Mainland for its trade and
finance industries, Macao’s customers also predominantly
come from its large neighbour. There has been a
remarkably close relationship between Mainland GDP
growth and gaming revenues in the SAR, though as time
goes by this correlation is likely to become looser. The
more austere tone of the new Communist leadership,
which eschews grand banquets and other conspicuous
displays of wealth, may hurt Macao’s tourism/gambling
industry. On the other hand, it’s also conceivable that
rich Chinese will come to the territory to splash out in a
way that is increasingly frowned on at home. A major risk
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 013
for the economy revolves around travel restrictions and
the new rulers in Beijing may be less inclined to allow a
freewheeling vice that is outlawed in other parts of the
People’s Republic.
that result in such an unsustainable situation. Current
non-performing loan rates suggest that there’s no
problem, but an economic downturn is inevitable at some
point and this will expose those swimming naked.
Our central forecast is that there will be some let-up in
gaming revenue growth as the Mainland economy slows
and sobriety becomes the rule. Lower growth prospects
are also likely to weigh on capital investment in the
medium term. The current slowing cycle is expected to
run through 2013, leaving GDP up by about 7.5% year
on year. In 2014 and 2015, Macao is projected to pick up
some speed, resulting in growth rates of 8.5% and 9.2%
respectively, once gaming revenues grow faster again and
new casinos are built.
The role of the government in propagating the current
credit boom obligates it to deal with the fallout if there is
a credit bubble that bursts. Fitch Ratings estimates that
general government debt currently amounts to about
50% of output, a manageable amount. Bank credit
amounted to roughly 130% of GDP at the end of 2012.
Even if a third cannot be repaid and the government
assumes the resulting debt burden in order to save the
banking system, then its debt burden rises to about
90% of output, which is fairly thin ice. Such an extreme
scenario is unlikely, but it illustrates that China’s capacity
for bail-outs is limited.
The earlier the credit cycle turns the better
We have argued in this report that Chinese savings are
resulting in massive amounts of investment and that the
expansion of credit is a side effect of this process. The
joint direction of travel – savings, investment and credit
move together in a closed economy – may be logical,
but that is not to say that it happens at the right pace.
Investment in productive capacity is a positive in terms of
raising output and ultimately living standards. Problems
only arise when the return of the new capital is insufficient
to cover its cost in terms of interest and loan repayment.
The continued provision of plentiful credit allows
borrowers that have invested in failed projects to borrow
new money to meet their financial obligations and stave
off collapse in the hope of turning fortunes. The widely
reported empty apartment blocks, shopping malls and
roads are the most obvious examples of investments
icaew.com/economicinsight
cebr.com
An explicit bail-out of banks’ bad debt will probably
be necessary at some point. That will prove costly and
many lenders to non-banks may not benefit from having
their deposits protected. More risk – in this case a high
probability of some loss of capital – is the flipside of higher
interest rates for wealth management products. However,
depositors will also have to bear the burden of the current
system. Negative real interest rates represent a transfer
of resources from savers to borrowers. More financial
repression is on its way and, as with an undervalued
renminbi, households will bear the cost of China’s
industrial policy. While a crash may be avoided thanks
to the availability of abundant domestic savings, heavy
credit losses are likely to be on their way. They may be the
catalyst that will lead China to get serious about changing
its growth model towards more domestic consumption
and take the painful but necessary steps to do so.
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 013
For enquiries or additional information, please contact:
Vivian Yu
T +86 10 8518 8622
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 140,000 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 706, Tower E1, Oriental Plaza
No.1 East Chang An Avenue
Dong Cheng District
Beijing100738, China
icaew.com/china
ICAEW
Chartered Accountants’ Hall
Moorgate Place
London
EC2R 6EA UK
icaew.com
© ICAEW 2013 MKTPLN12257 05/13