JPMorgan’s China economists are out with a new report pondering 10 big questions that are likely to dominate the thinking of China economy watchers in 2015.
However, for most investors and traders the key questions they want answered is whether the Chinese government is going to downgrade its growth target for 2015, and if so, to what?
Well, that’s the first question tackled by JPMorgan. The broker reckons Beijing will cut its 2015 growth target to 7% from 7.5% in 2014, although they think there is a 30% probability the government may target a range between 7% and 7.5%. While acknowledging there may be a willingness by the government to lower the growth target, the bank sees it as unlikely that Beijing will follow the advice of the International Monetary Fund and drop the 2015 target to between 6.5% and 7%.
JPMorgan’s own forecast is for 7.2% growth in 2015 based on relatively stable growth in the service sector and an upbeat outlook on China’s current account surplus. However, they do see an ongoing drag from weakness in the real estate sector and overcapacity in manufacturing.
To save our readers the time of reading the 26 page report, here are the highlights from the other nine questions.
Will the economic rebalancing continue? Short answer – yes;
While we expect adjustment in the property sector and overcapacity in several industries will continue to weigh on the manufacturing sector into 2015, the service sector will likely
continue to expand in a relatively stable manner. Thus, we expect continued, steady economic restructuring.
Will the real estate market adjustment continue? What are the implications? To cut a long story short, real estate is still going to be a problem child;
We expect the property market adjustment will continue in 2015, as oversupply remains in the near term. Housing prices may decline further but should stabilize in 2H15. From peak to bottom, we forecast the price decline will be in the 5%-10% range at the national level, with tier-2 and tier-3 cities generally facing greater price falls. It is worth noting that housing affordability, as measured by the price-to-income ratio, should improve significantly even with modest house price declines, as household income growth in China is strong and forecast to remain so amid the economic rebalancing.
Will financial risk in China remain at bay? While acknowledging that financial system risks are elevated, the broker does not expect a full scale crisis to emerge in the next couple of years;
Financial-system risks, while elevated, are unlikely to evolve into a full-scale crisis in the next couple of years. First, although corporate debt is very high by historical and international standards, household debt is very low at 25% of GDP, while government debt, at 59% of GDP including central and local government debt but not SOE debt, remains manageable. Second, despite the economic slowdown, our projections for above-7% growth in 2014 and 2015 are still the highest, by far, among the major economies. Third, China’s debt is mainly domestically held (external debt is only slightly above 10% of GDP), and the domestic saving rate is over 50%, the highest in the world. Fourth, despite the rapid growth in debt noted earlier, total assets also have risen quickly; hence, leverage ratios have remained stable outside a few sectors, notably real estate and mining. In the government sector, holdings of state assets and US$4 trillion in FX reserves are strong buffers to protect against a potential crisis. Finally, China is relatively closed to international capital flows; hence the risk of a capital flight-driven crisis is fairly low.
Will China Face a fiscal cliff? On this question, JPMorgan believes a series of fiscal reform measures, mainly focused on local government debt, should allay some of the more pressing concerns;
The new rules should help contain local government debt problems. In the near term, the shift from LGFV financing to municipal bond financing should mitigate the maturity mismatch between funding and local government projects and lower the interest rate burden, thus helping to reduce the default risk. In the long run, it could strengthen market discipline for local government borrowing, as municipal bonds tend to have stricter requirements (e.g., external rating requirements, disclosure of fiscal balance sheets, and monitoring of government spending) than financing by the shadow banking system.
Is the PBoC operational framework at a crossroads? Translation – has the People’s Bank of China changed the way it conducts monetary policy? Given the recent cut in interest rates, coupled with the adoption of various new liquidity tools, it seems like a fair question to ask.
The main reason for the change in the operational framework of monetary policy is concern about distortions in traditional monetary easing. When the central bank eases monetary policy via rate cuts or credit acceleration, there is generally unequal treatment in the credit market in that local governments and SOEs (due to their “implicit debt guarantee”) and borrowers who are not sensitive to interest rates (and are willing to accept higher interest rates) crowd out other sectors.The new operational framework is a compromised near-term solution to address the above concerns. The targeted approach aims to level the playing field in the credit market by providing liquidity to support certain sectors, including SMEs, affordable housing, and the rural sector. However, the new approach has its own shortcomings from the start. It could generate new distortion as the PBOC may lack the expertise to guide sector lending. Separately, the transparency of monetary policy operations under the new framework has been limited, causing unnecessary market uncertainty.
So what does this mean for monetary policy in 2015? Well, JPMorgan believes the recent rate cut announcement signals a shift towards more aggressive easing. At least one more rate cut is expected in 2015, coupled with other measures such as a lowering of the reserve requirement ratio.
How does the global oil price collapse affect China? Not surprisingly, the broker sees cheaper energy prices steering down inflation to around 1.5% in 2015. However, JPMorgan underscores the difference between ‘good’ deflation (as measured by the producer price index) caused by lower oil prices compared to ‘bad’ deflation caused by the overcapacity haunting many of China’s industries.
… given China’s role as a significant net oil importer, PPI deflation arising from an exogenous, supply-side induced decline in global oil prices would lift corporate profits and real household income, supporting economic growth.
Will China’s current account surplus widen again? What is the implication for the CNY? In a nutshell, cheap oil means the current account surplus widens, which in turn raises pressure on the Chinese yuan to appreciate. But JPMorgan doesn’t expect the yuan to continue rising in 2015;
We expect the USD/CNY to trade at 6.15 at the end of 2015, unchanged vs. our forecast of 6.15 at end-2014. But we expect also expect more exchange-rate volatility: In 1H15, the CNY is likely to move back above 6.20 amid weak domestic economic performance and a strong USD buoyed by expected Fed tightening.
What is the potential impact of China’s rebalancing in the rest of the world? It’s China! Of course rebalancing in the world’s second largest economy is going to have a global impact. While declaring the global commodities super-cycle is “over”, JPMorgan doesn’t think China’s commodities demand will collapse;
Economic rebalancing does not mean China will give up investment. The investment/GDP ratio was 47.8% in 2013, which we consider unsustainable. The rebalancing aims to bring it down to a more reasonable level, e.g. 35%-40% by 2020. This means investment in China will decelerate and expand less rapidly than GDP, but should not collapse.
And finally, what are the next steps in China’s ongoing structural reforms? Basically, the Chinese government is expected to continue fiscal and administrative reforms , as well as reforms of state owned enterprises, land policy, and household registration.
At this stage, we believe the government will continue to push forward in small steps in all areas. Thus, we have seen some progress in nearly all areas, but find it difficult to identify break-through achievements. The gradual reform approach should help to address financial stability concerns during the process, which we consider a priority given the rapid accumulation of financial imbalances in recent years.