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Country report China

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Growth in China is slowing. The housing market adjustment is probably not yet over, while the government may soon allow some trust loan defaults. The anti-corruption campaign has continued.

Strengths (+) and weaknesses (-)

(+) Exceptionally strong external position

China’s vast stock of FX reserves, amounting to USD 3,843bn at the end of 2014, and low external debt give it an exceptionally strong external position. Capital controls also reduce external vulnerability (though controls on outward investment have been eased recently).

(+) Large economy with sizeable growth potential

China has a large and growing economic market. In PPP terms, China is now the world’s biggest economy. Meanwhile, growth is likely to remain strong as China’s GDP per capita is still relatively low and the country has so far successfully moved up gradually on the technological ladder, though policy reforms will be needed to sustain growth in the longer term.

(-) Existing growth model is unsustainable

China has to change its growth model to reduce inefficiencies and ensure sustainable growth in the future. However, many crucial reforms still have to be implemented.

(-) Weak accountability of the government

High levels of corruption, weak protection of human rights, strong influence of the Chinese Communist Party on the judiciary and lack of democracy implies that the Chinese population cannot hold the government accountable for its actions, which increases the risk of public unrest. 

Key developments

1. Growth likely to slow further in near future

After economic growth fell to its weakest level in 24 years in 2014, growth is likely to slow further in the the coming years. According to official data, economic growth decreased slightly to 7.4% y-o-y in 2014. In fact, most widely-used growth proxies suggest that economic growth may already have fallen further than the official data suggest. The growth slowdown is likely continue in the near future, as the government is trying to rein in high credit and investment growth and reform the growth model. GDP has already become a less important key performance indicator for local government officials. Instead, achieving employment and environmental targets have risen in importance. Premier Li Keqiang is expected to announce a 2015 growth target for China of only about 7% at the annual parliament session in March and Shanghai (the region) will for the first time in recent history not set a growth target at all. While monetary policy has become a bit more accommodative in recent months, the government still seems intent on avoiding new massive stimulus. So far, it seems that the slowdown has not resulted in the feared social instability risks, as most indicators suggest that the labour market has remained rather tight. According to official data, 13.2 million new urban jobs were created in 2014, which implies that government more than achieved its job creation target.

2. Housing market and shadow banking risks

The economic slowdown in 2014 was related to a housing market adjustment. After a couple of years of very high growth in housing investment, sales of houses, and also house prices started to fall in 2014. A pick-up in sales has taken place in late 2014, after the government eased the still relatively strict mortgage financing conditions. While the quality of statistics has improved somewhat in recent years, it is still hard to obtain a good overall picture of the health of the Chinese housing market. However, some inventory data suggest that the adjustment may not yet be over, especially not in third and fourth tier cities, which could pose problems for developers and local governments. Meanwhile, the government seems to be preparing for some (controlled) defaults to take place in the shadow bank sector. First, a deposit insurance scheme for regular deposits is likely to be launched soon. Second, the government has improved the regulation of the shadow banking sector and reduced exposures of banks and local governments to trust loans (one of the main types of shadow lending). So far, the government has not allowed full-defaults of trusts, but as the impact of potential defaults will now be more contained, the government may allow some trust loans to default in 2015.

3. Strong capital outflows in Q4

In the final quarter of 2014, China’s net capital outflows reached a record USD 91bn. Sizeable net capital outflows are relatively rare in recent history. However, in the last three quarters there has been a sizeable and growing net capital outflow. As a breakdown is not yet available for Q4, it is not fully clear what is behind these outflows. They are likely to be related to rising overseas investment by Chinese companies and could also be the result of central bank policy. However, they could also reflect capital flight, possibly related to China’s big anti-corruption campaign. In recent years, the government has eased restrictions on outward investment. So far, many many capital controls remain in place, which coupled with China’s enormous stock of foreign exchange reserves and net creditor position means that external liquidity risk remains low. However, rising and continued capital is something to be watched, as it could imply that China is less able to insulate its financial system, which could imply future financial stability risks.

Figure 1: Growth slowdown
Figure 1: Growth slowdownSource: EIU & Rabobank
Figure 2: Vacancies
Figure 2: VacanciesSource: Macrobond

4. Anti-corruption campaign reaches upper ranks of government and banking sector

Xi Jinping’s anti-corruption continues to dominate China’s domestic politicla agenda. In the past year, the campaign has reached the most senior levels. In December, Chinese media announced the arrest and formal charge against Zhou Yongkang, a former member of Politburo Standing Committee and China’s ex-security chief. Furthermore, an investigation into Ling Jihua, a senior aide to former President Hu Jintao, has been announced. The campaign has also reached the banking sector, as it became clear in recent weeks that MinSheng Bank and Bank of Beijing 2015 are being investigated. The far-reaching anti-corruption campaign has boosted the power of President Xi Jinping, who is now widely seen as the the most powerful president since Deng Xiaopiing. The concentration of power in his hands could make it more easier to remove opposition from vested interest and implement the far-reaching reforms the government intents to introduce in the coming years. At the same time, the concentration of power could also create some risk. In this respect, it is also noted that the government has created tighter control over education and the internet and blocked the use of Virtual Private Networks to access some western sites.

Factsheet of China
Factsheet of ChinaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

China is the second-largest economy in the world in nominal GDP terms (USD 10.4 trillion in 2014) and the largest economy in PPP terms (USD 18 trillion in 2014). At the heart of China’s economic success has been its successful export- and investment-led growth model. However, in recent years, growth has been increasingly driven by credit and (real estate and infrastructure) investment growth. Meanwhile, adverse side effects, such as a rapid rise in income inequality and major environmental problems have become too big to ignore. China’s growth model will have to be changed and become more consumption-driven instead of investment-driven. Innovation will have to be nurtured, while environmental responsibility will have to gain in importance. The 12th 5-year plan, launched in March 2011, and the late-2013 Third Plenum address these issues, but implementing the plans correctly and timely will be a key challenge for Chinese authorities while major downside risks, such as a sharp economic slowdown or public unrest are present.

The People’s Republic of China, established in 1949, is a socialist one-party state ruled by the Chinese Communist Party (CCP). Power is centralized in the CCP and the support of the People’s Liberation Army and a well-developed internal security system safeguards political stability. The availability of information is heavily controlled by the government. Press freedom and freedom of speech are heavily restricted, while the judiciary is not independent. As a result, developments in China, especially political ones, remain clouded and difficult to gauge due to lack of transparency. In recent years, President Xi Jinping has launched a far reaching anti-corruption campaign, which has helped him to increase his personal power.

Economic indicators of China
Economic indicators of ChinaSource: EIU, Rabobank
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