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Economic Research
November 28, 2014
Special Report
JPMorgan
forecast
%oya
14
14
12
12
%q/q saar
10
10
8
6
16
8
06
07
08
09
10
11
12
13
14
15
Haibin Zhu
(852) 2800-7039
haibin.zhu@jpmorgan.com
Grace Ng
(852) 2800-7002
grace.h.ng@jpmorgan.com
Lu Jiang
(852) 2800-7053
lu.l.jiang@jpmorgan.com
www.jpmorganmarkets.com
Economic Research
Ten questions about China
November 28, 2014
Chinas economic slowing is a major theme in the current global economic developments.
Chinese policymakers will hold the annual Central Economic Working Conference in the
coming weeks, which will set key economic targets for 2015. In this special report, we
elaborate our views on 10 key issues regarding Chinas growth and policy outlook (chart 1),
and the interactions between the Chinese economy and the rest of the world.
Economic Research
Ten questions about China
November 28, 2014
30
25
GDP growth
14
20
12
Electricity consumption
15
10
10
6
2010
2011
2012
2013
0
2015
2014
18
16
10
14
Electricity consumption
12
9
8
10
GDP growth
7
2010
8
6
2011
2012
2013
2014
4
2015
J.P.Morgan
forecasts
Government's growth
target
10
8
6
98
00
02
04
06
08
10
12
14
We expect the government to lower its growth target to 7% for 2015 from 7.5% in
2014 (see Chart 4). (We think there is a 30% probability that the target could be a range
between 7% and 7.5%, or a specific number within this range.). Meantime, structural
reforms will continue (Question 10). President Xi has highlighted three features of the new
normal for the Chinese economy in the coming years: a transition from high growth to
modestly high growth; economic rebalancing and more inclusive growth (i.e., faster service
sector growth and reduced income inequality); and a transition from input- and investmentdriven growth to innovation-driven growth. Government officials seem cautious on the
2015 outlook, as reflected in growth forecasts from the official sector (State Information
Center: 7.3%; China Academy of Social Science, or CASS: 7%; a senor official from the
National Development and Reform Commission, or NDRC: 7%). By contrast, in late 2013,
the CASS and NDRC forecasts for 2014 growth stood at 7.8% and 8%, respectively.
Despite an apparent willingness to lower the growth target, it is unlikely, in our view, that
the Chinese government would adopt the IMF recommendation (in the Article IV report) to
lower the 2015 growth target to 6.5%-7%.
Our forecast for 2015 full-year GDP is 7.2%, with consumption, investment and net
exports contributing 3.4%-pts, 3.1%-pts and 0.7%-pts, respectively. In our view, the
fundamental growth drivers may not change much in the near term, despite ongoing
economic rebalancing. The positive drivers include relatively stable growth in the service
sector, as well as the constructive outlook for Chinas current account surplus (Question 8).
One major drag on economic growth, in our view, is the continued slowdown in real estate
investment growth (Question 3), along with persistent overcapacity in parts of
3
Economic Research
Ten questions about China
November 28, 2014
7.4
7.2
1Q14
2Q14
7.4
7.4
6.3
7.5
7.4
7.9
7.3
7.4
7.0
7.3
7.3
6.3
7.1
7.2
7.1
7.1
7.1
8.0
7.2
7.2
7.3
Economic Research
Ten questions about China
November 28, 2014
Chart 6: Real GDP vs. real urban and migrant worker wages
%oya
Secondary
industry
48
20
46
Tertiary
industry
44
15
10
42
40
Real GDP
25
06
08
10
12
14
2011
2012
2013
2014
6
4
2
0
-2
-4
2008
2009
2010
2011
2012
2013
2014F
2015F
Another key government macro policy target is for household income to grow in line with,
or preferably outperform, overall economic growth, with a greater share of national income
distributed to the household sector over time. From this perspective, recent trends seem to
be tracking the governments goals (see Chart 6): During the first three quarters of this
year, nationwide household disposable income per capita rose 8.2%oya in real terms (and
10.5% in nominal terms), outperforming real GDP growth at 7.4% (and 8.5% in nominal
terms).
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.
With regard to the composition of overall GDP growth, we expect the investment
contribution, which picked up to 4.1%-pts in 2013 after falling for three consecutive years
through 2012, likely will ease to 3.0% in 2014 and remain near that level next year,
marking the lowest level of investment contribution to overall growth since 2000. The final
consumption contribution to GDP likely will slip somewhat to 3.5%-pts in 2014; we look
for it to hold steady close to that level in 2015. Meanwhile, the net exports contribution to
overall GDP growth, after averaging 0.3%-pt annual drag in the three years through 2013,
looks poised to rise to 0.9%-pt in 2014 and remain at a relatively elevated 0.7%-pt in 2015,
given our outlook for a decent upturn in global demand and lingering sluggishness in
Chinese domestic demand (see Chart 7).
Economic Research
Ten questions about China
November 28, 2014
Economic Research
Ten questions about China
November 28, 2014
%oya
25
%oya, 3mma
80
Tier-1 cities
National (100 cities)
20
Tier-2 cities
15
60
Tier-3 cities
10
Commercial
Residential
Total
40
20
0
-5
2012
2013
2014
0
2010
2015
2011
2012
10
05
Source: PBOC
07
2013
2014
2015
09
11
13
0
2008
Manufacturing
Wholesale & retail
Real estate
Overall
Housing mortgage
2009
2010
2011
2012
2013
2014
Source: PBOC
for weak developers to exit the business, but we do not expect trends to put undue stress on
the banking system.
%oya
35
30
25
20
15
10
2008
2009
2010
2011
Economic Research
Ten questions about China
November 28, 2014
2012
2013
2014
% of TSF
%
70
125
60
100
50
75
40
50
30
25
20
10
2015
-25
Bond, equity
& others
2012
2013
Non-bank
financing
Bank loans
2014
Economic Research
Ten questions about China
November 28, 2014
2008
2009
2010
2011
2012
2013
2014Q3
40.40
32.00
1.14
1.03
5.33
1.87
45.43
54.31
42.56
1.47
1.49
6.02
2.50
59.87
68.33
50.92
2.05
3.83
6.75
3.29
72.50
81.16
58.19
2.49
4.85
7.20
4.01
85.03
96.92
67.29
2.74
5.90
7.76
4.45
100.48
114.24
76.63
2.96
6.68
8.67
4.96
118.23
127.07
84.74
3.27
6.80
9.82
5.48
132.31
12.77
5.33
5.57
1.87
3.72
3.35
28.94
17.34
6.02
9.02
2.30
5.54
4.80
36.99
20.36
6.75
10.72
2.89
7.51
6.26
44.62
24.11
7.20
13.50
3.41
8.88
7.24
52.04
27.76
7.76
16.20
3.80
10.44
8.24
62.28
31.83
8.67
19.00
4.16
12.98
10.02
73.42
35.35
9.82
21.00
4.53
14.75
11.35
82.21
31.4
128.6
144.7
40.6
11.9
92.1
34.1
159.3
175.6
50.9
16.2
108.5
40.2
170.2
180.6
50.7
18.7
111.1
47.3
171.5
179.7
51.0
18.8
110.0
51.9
186.8
193.6
53.5
20.1
120.0
56.9
200.8
207.8
56.0
22.8
129.1
60.2
211.2
219.9
58.8
24.5
136.6
Note: 5: others include debt issued by central government on behalf of the local governments, Ministry of Railway debt and carry-over of
the restructuring loans held by the big four AMCs.
Source: NBS, NAO, J.P. Morgan
%
15
10
5
0
-5
00
02
04
06
08
10
12
14
estimates show that the return on capital fell from 17.0% in 2008 to 8.0% in 2013 (Chinas
big fall in productivity, August 22, 2014).
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, Chinas
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
Economic Research
Ten questions about China
November 28, 2014
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.
Nonetheless, complacency by policymakers and investors would be misplaced. While
the above-discussed sources of resiliency may be able to delay a crisis, they cannot resolve
the financial vulnerabilities. Chinas financial imbalances today bear some resemblance to
the excesses that contributed to Japans stagnation in the 1990s. In particular, we note
certain similarities such as a debt increase and housing boom as well as an aging population
(of course also differences such as the stage of economic developments) in terms of the
challenges China is facing (How similar is China to Japan in the late 1980s? July 19,
2013). In Japans case, the economy failed to deliver on structural reform and the banking
system problem eventually got out of control. Serious banking restructuring occurred in
Japan only after the crisis.
In a downside risk scenario, we estimate China may hit the tipping point in 2018-2019
if structural reforms are not implemented. On the domestic front, debt will continue to
rise if imprudent lending continues. Asset quality will deteriorate if the system continues to
tolerate evergreen loans, allowing loss-making companies to survive by paying only
interest. This could evolve into a zombie system as observed in Japan in the 1990s. From
a global perspective, we expect the US will have completed its tightening cycle by 2018,
and the Euro area and Japan may have started to exit monetary easing, potentially driving
capital outflows from China and other emerging markets. In addition, the aging of Chinas
population likely will result in a decline in the saving rate, and capital account openness
may add to the risk of capital outflows. Last, while the above-mentioned factors could help
China to avoid a crisis in the near term, this may only mean that it will take longer for risks
to materialize than in most other countries. Casual observation suggests that it could take a
decade for the current excess leverage and credit misallocation problem to balloon out of
control, as happened in Japan from late 1980s to the late 1990s and in China from early
1990s to early 2000s. Chinas current credit cycle started to build up in 2008-09 and may
require addressing in 2018-2019 if structural reforms fail to deliver new sources of growth
and the debt problem continues to build up.
The Chinese government seems to be pursing a strategy of growing out of the
problem by putting restrictions on debt for new projects while adopting a lenient attitude
for the rollover of existing debt. A repeat of the successful experience of NPL disposal in
the previous banking crisis in early 2000s would be desirable: at the time, the size of NPLs
(as measured relative to GDP), which looked threatening at the beginning, diminished
quickly when the economy grew rapidly; in addition, many bad assets (especially land)
turned out to be profitable in the subsequent asset market boom.
The current situation is not comparable to the early 2000s. On the comforting side, the
NPL ratio is much lower at this moment: our estimate of a 5%-7% NPL ratio (taking into
account possible losses from shadow banking) is sharply lower than the roughly 30% NPL
ratio in early 2000s. However, the size of total debt (as a % of GDP) is much higher now.
More important, in the next five to 10 years, we consider it unlikely that the Chinese
economy will rebound to double-digit GDP growth as it did in the past decade: we think
Chinas potential growth likely will fall 6.5% in 2016-2020 even with gradual progress in
structural reform (Chinas growth trend to slow below 7%, February 1, 2013).
While growth is necessary to address the debt problem we think other policy measures
are also important to address existing issues now rather than later. These include: (i)
10
Economic Research
Ten questions about China
November 28, 2014
strengthening supervision and regulation, especially to break implicit debt guarantees; (ii)
lowering the tax and fee burden for the corporate sector and reducing the role of
government (administrative reform) to improve corporate profitability; (iii) taking PPI
deflation risk seriously and accelerating resource pricing reform (oil, gas, electricity, water,
transportation, etc.); (iv) supporting industry upgrades and restoring productivity growth
(via market-oriented reforms such as reducing government intervention, opening
competition and supporting R&D); (v) further developing the capital markets and establish
a multi-channel financial system. This could reduce the concentrated risks in the banking
system and convert some debt into equity financing; (vi) gradually recognizing losses rather
than continuing to postpone them. Banks need to write off bad loans and the government
should use fiscal resources or state-owned assets to cover some debt losses.
11
Economic Research
Ten questions about China
November 28, 2014
-5
-10
-15
2007
2008
2009
2010
2011
2012
2013
2014f
12
Economic Research
Ten questions about China
November 28, 2014
Our posited increase in the fiscal deficit for the central government does not necessarily
result in an increase in government investment. The fiscal deficit could be used to reduce
the corporate tax burden or to increase support (via tax or financing) for R&D investment
by enterprises. Alternatively, it could be used to improve the social safety net and
indirectly encourage household consumption.
Another possible offset for tighter local government funding constraints may come from
the promotion of social capital participation, e.g., in the form of public-private
partnerships or franchise operations. The government has tried this approach to support
public projects in areas such as infrastructure, water supply, and waster disposal. This
year, 80 projects were selected to encourage social capital participation. However, we are
cautious about the near-term policy impact. First, public investment projects frequently
require a long spending cycle and yield a low return; thus attracting social capital can be
challenging. Second, as public-private partnerships are not backed by a government
guarantee, it may not be easy for investors to get external financing at a reasonable cost.
Finally, total debt in the corporate sector has risen to a very high level (see Question 4),
which can add another layer of difficulty in promoting social capital investment in a
deleveraging environment. Our recent field trips suggest that PPP participants are mainly
SOEs at this moment.
Economic Research
Ten questions about China
November 28, 2014
Third, credit easing focuses on compositional shifts (from shadow banking to bank loans,
from short-term financing to medium- and long-term loans) to improve the efficiency of
credit to the real sector. In fact, TSF growth (in stock terms) fell to the lowest level on
record in October (14.3%oya), mainly due to a net decline in trust loans and bank
acceptances outstanding (key shadow bank funding channels) in recent months.
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.
Hence, the announcement of a rate cut on November 21 surprised the market. What
triggered the change? What does it mean for the monetary policy outlook in 2015?
From a macroeconomic perspective, weak growth and low inflation set the stage for rate
cuts. The economy had a weak start in 4Q, with IP edging up 0.5%m/m, sa in October.
Although credit components have shifted encouragingly (from shadow banking funding to
bank lending) since 3Q, the deceleration in aggregate credit is worrisome, in our view.
November data are not available at present, yet weak credit growth may continue, and
economic activity may be soft, in part due to a temporary shutdown of some activities
during the APEC meeting. In our view, the rate cut, in part, was a response to possibly
weaker-than-expected economic activity in 4Q.
Another reason, which may be more important, is that lowering corporate funding costs is
a government priority. The State Council reiterated this objective throughout the year,
most recently two days before the rate cut announcement. Unfortunately, the new monetary
policy operational framework seemed ineffective in achieving this target. Although lower
short-term interbank rates passed through to lower bond yields (see Chart 16), average bank
lending rates and other funding cost indicators like average trust yields and underground
lending rates have not fallen much (see Chart 17). By contrast, cutting policy rates is seen
as a direct and more effective instrument to bring down corporate funding costs, as banks
actual lending rates are often distributed around the benchmark lending rates.
We think the rate announcement indicates a shift toward more aggressive easing. As
such, it is a big setback for the new operational framework, but in our view, it is too early to
say that the PBOC will give up on the new framework. We think it may employ a mixture
of traditional and unconventional easing, as long as it can deliver policy objectives.
Moving into 2015, we expect at least one more interest rate cut, supplemented by
quantitative measures that may include RRR cuts (see Chart 18), targeted quantitative
measures (e.g., PSL, MLF, SLF), and possible adjustment in loan-to-deposit ratio (LDR)
calculations. We have two 50bp RRR cuts in our 2015 baseline scenario, but there could be
14
%
5.0
% both scales
8.00 Average bank lending rate
10-Year CGB
4.5
4.0
3.5
3.0
Economic Research
Ten questions about China
November 28, 2014
2.5
Jan 13 Apr 13 Jul 13 Oct 13 Dec 13 Apr 14 Jul 14 Oct 14 Dec 14
Source: Bloomberg, J.P. Morgan forecast
24
7.50
23
7.00
22
6.50
21
6.00
20
5.50
1-Year CGB
Trust product
consolidated yields
5.00
2012
2014
19
18
2015
JP Morgan
forecasts
% per annum
8
7
6
5
4
3
2
06
07
08
09
10
11
12
13
14
15
more. The market appears to expect that a new LDR calculation could include interbank
deposits in the denominator. If that happens, banks may face additional reserve
requirements and the PBOC could implement RRR cuts (perhaps a one-off 100bp cut) to
offset the resulting increase in required reserves.
Economic Research
Ten questions about China
November 28, 2014
Chart 20: OPEC basket crude price and China's gasoline retail price
J.P.Morgan commodity
price index
60
40
10
China's PPI
20
0
-20
-40
-60
08
10
12
14
15
10
5
0
-5
-20
-5
-40
-10
-60
2009
2011
2012
2013
2014
-10
-15
-20
2015
to 0.4% since the global financial crisis, along with further liberalization of domestic fuel
prices.
Overall, considering the expected soft trends in global oil prices going into 2015, we look
for Chinas CPI inflation to ease to about 1.5%oya in 2015, from a projected 2.0% in
2014. There are some concerns about a potential rebound in domestic food prices,
particularly pork prices. However, so far food price inflation has been tame at a 2.4%
3m/3m, saar pace in October, with pork prices rising at a moderate 3.6% 3m/3m, saar rate.
Easing inflationary pressure was an important driver behind the unexpected rate cut in
November 2014, in our view. Separately, subdued global commodity prices provide a good
opportunity for China to push ahead with price reform for a range of resource-based
utilities, such as oil, natural gas and electricity (see Chart 20).
In addition, given Chinas role as a net oil importer (see Chart 21), the decline in global
oil prices is a positive terms-of-trade shock for the country that should help to lift its
merchandise trade and current account surpluses. We estimate that every US$10/bbl decline
in oil prices would boost Chinas current account surplus by about 0.3% of GDP (see
Question 8). Moreover, while falling global oil prices imply lingering deflationary pressure
at the PPI level, it is useful to differentiate the macro implications of PPI deflation arising
from an exogenous, supply-side induced decline in oil prices vs. PPI deflation driven by
sluggish domestic demand. In particular, PPI deflation driven by structural overcapacity
and a cyclical downturn in the industrial sector, as seen in the last two years, exerts
downward pressure on profitability in the industrial sector that, in turn, drags down
manufacturing investment growth. On the other hand, given Chinas 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.
16
Economic Research
Ten questions about China
November 28, 2014
The projected widening in Chinas current account surplus largely reflects the latest trend in
merchandise trade, given the combination of gradual improvement in global demand (led
by the US economy), the relatively sluggish domestic economy, and declining global
commodity prices. Chinas merchandise trade surplus has widened notably since July this
year, with the cumulative trade surplus for the first ten months of the year expanding to
US$276.7 billion, compared to US$200.0 billion for the same period last year. This
increase came on the back of steady rise in exports. In the first three quarters, adjusting for
the data discrepancy between Chinas exports to Hong Kong and Hong Kongs reported
imports from China, Chinas export growth accelerated from 3.1%oya in 1Q to 7.8% in 2Q
and 11.7% in 3Q (see Chart 23). Meanwhile, import growth has been persistently weak in
the 1%-2%oya range in each of the three quarters. To some extent the sluggishness of
nominal imports reflects a price effect: overall import prices fell 2.7%oya in the first nine
months of the year, with a more significant decline in commodity prices, while import
volumes of major commodity products, including iron ore, copper and crude oil, have held
up relatively well this year; see more details under Question 9).
For 2015, as J.P. Morgan looks for the global economy to continue accelerating, Chinas
export sector likely will continue to expand solidly; we expect merchandise exports to rise
about 9%oya in 2015. On the other hand, as weakness in Chinas domestic demand persists,
weighed down by further adjustment in the real estate sector, and as the industrial sector
continues to struggle with overcapacity, the growth in major commodities import volumes
likely will ease, while commodity prices remain soft. Both factors will contribute to
continued subdued growth in nominal imports, in our view. In particular, considering the
impact of oil price alone, we estimate that every US$10 decline in oil prices would to
boost Chinas current account surplus by about 0.3% of GDP. Putting these factors
together, Chinas merchandise trade surplus will likely expand further, with the current
account surplus rising toward 3.5% of GDP in 2015.
The widening current account surplus should put additional appreciation pressure on
the CNY. Indeed, the building CA surplus has been an important driver of CNY
appreciation since June 2014, when the PBOC stopped FX intervention amid its effort to
push exchange rate regime reform. The jump in the trade surplus in 3Q was beyond market
expectations, and, in our view, together with the carry trade incentive, drove the reversal of
the CNY trend and the roughly 2% appreciation between June and October (see Chart 24).
Will the CNY continue to appreciate into 2015? We do not think so. We expect the
USD/CNY to trade at 6.15 at the end of 2015, unchanged vs. our forecast of 6.15 at end2014. 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.
A strong USD should be a major challenge for CNY movements in 2015. Our global
forecast calls for a strong USD against other major currencies, driven by the divergence of
monetary policy between major advanced economies (the Fed likely will start hiking rates
in June 2015, yet we expect the BOJ and ECB to step up quantitative easing policies). By
extension, most emerging market currencies may follow the EUR and JPY, falling against
the USD, and the risk of competitive devaluation cannot be ignored. If the CNY appreciates
against the USD, in REER terms, it would be a drag on exports, which is one of the few
bright spots in the current economic outlook.
17
Economic Research
Ten questions about China
November 28, 2014
% of GDP
Non-oil
balance
Overall trade
balance
60
12
10
40
20
-20
-40
Oil balance
2010
2011
2012
2013
2014
%oya, 3mma
20
Export
05
07
09
11
13
15
CNY/USD
15
03
10
6.40
Mid-point fixing
6.30
6.20
0
-5
-10
2012
J.P. Morgan
forecasts
6.10
Import
2013
2014
2015
6.00
Jan 12
Dec 12
Jul 13
Dec 13
Jun 14
Dec 14
The more attractive policy, in our view, is to maintain a stable CNY in REER terms,
which implies a modest depreciation against the USD in 2015. However, improvement
in the current account surplus implies that such depreciation would be difficult to achieve
without substantial intervention by the central bank. Given the multiple factors that will
likely coexist in 2015 (trade surplus, carry trade, and RMB internationalization supports a
strong CNY but domestic softness and the incentive to support exports call for a weak
CNY), we think the CNY will trade in a range in 2015, albeit with significant short-term
volatility.
Since the global financial crisis, China has accounted for almost all of the increase in global
commodity consumption, including crude steel, aluminum, copper, nickel, zinc, and iron
ore (see Table 3). Strong economic growth in China, especially rapid growth in fixed asset
investment (FAI), drove robust commodity demand (see Chart 25). However, Chinas
growth has trended downward in recent years, and the economic rebalancing (from
manufacturing to services, from investment to consumption) implies a disproportionate
18
Economic Research
Ten questions about China
November 28, 2014
% net increase in
% of global demand
2007
34
32
26
31
25
43
2009
47
39
37
40
34
55
2011
45
43
39
42
41
55
2013E
45
45
41
44
46
59
global demand
2007 - 2013
87
84
121
109
101
79
Iron ore
Coal
Copper
Australia (45.3%)
Brazil (21.5%)
India (7.4%)
Iran (2.4%)
Russia (2.0%)
Indonesia (39.0%)
Australia (19.5%)
Mongolia (9.0%)
Vietnam (8.4%)
Russia (6.5%)
Japan (7.6%)
US (6.5%)
Korea (4.9%)
Australia (4.8%)
India (4.0%)
deceleration in FAI relative to the slowing in headline GDP growth. The implications for
the global commodity markets, in our view, are threefold.
First, the global commodity super cycle is over. On a global scale, to the extent that
Chinas role as a driver of global commodity prices gradually diminishes in coming years
(see Chart 26), the related adjustment in the international terms of trade should favor
commodity importers (especially in developed market economies). On the other hand,
commodity exporters will have to adjust their growth strategy (see Table 4), as Chinas
growth gradually slows amid its own economic restructuring.
Looking at the latest trends with some of Chinas major commodity trade partners, growth
in imports from Brazil slowed to 3.3%oya, ytd in the first 10 months of this year and
3.1%oya in 2013, notably slower than the robust annual average growth at 24% for the
three years through 2011. Similarly, growth in Chinas imports from Australia slowed to
4.9%oya, ytd in October, compared to 16.5%oya in 2013, and annual average growth at
31% for the three years through 2011.
Second, Chinas commodity demand should not collapse. Despite the economic
slowdown, Chinas imports of major commodities have held up reasonably well this year;
although industrial production growth slowed to 8.4%oya in the first 10 months of the year,
iron ore imports rose 16.4%oya during the same period, and copper imports rose 8.8%oya
and crude oil imports rose 9.0%oya (see Chart 27).
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.
19
Economic Research
Ten questions about China
November 28, 2014
40
35
60
Commodity import
volume
30
40
30
20
25
10
20
15
50
0
2008
2009
2010
2011
2012
2013
2014
-10
Note: Commodity import volume is a weighted aggregate index based on Chinas major commodity
imports. The base year is 2004.
Source: NBS, J.P. Morgan
Crude and
refined oil
160
45
China IP
J.P.Morgan aggregate
commodity price
index
30
15
0
10
11
12
14
13
15
-15
Coal-equivalent mn ton
4000
Iron ore
3500
140
3000
120
80
2500
100
2000
80
60
22
20
18
16
14
12
10
8
6
1500
Copper
10
11
12
13
14
15
1000
75
Energy
consumption
00
02
04
06
08
70
10
12
14
65
Separately, Chinas energy consumption should continue to increase. In recent years, the
government has reduced energy consumption intensity (energy consumption per unit of
GDP) by about 4% every year, but GDP has grown much faster (see Chart 28). Total
energy consumption increased by 28.7% between 2008 and 2013. We believe rising energy
demand and high investment imply that Chinas commodity demand will remain high.
Third, the structure of Chinas commodity and energy demand likely will change
substantially. For instance, as real estate investment has slowed in 2014 and continues to
decelerate in 2015, steel demand (24% of steel demand is related to housing and 34%
related to commercial property) likely will slow sharply as well, but copper demand may be
less affected due to the projected pickup in infrastructure investment.
Air pollution and environment protection are now a priority. The shift in the
governments environmental priorities could lead to structural changes in Chinas energy
consumption. In November 2014, the State Council announced its Energy Development
Plan (2014-2020). By 2020, the share of coal consumption should be less than 62%, the
share of natural gas should exceed 10% and the share of non-fossil energy should exceed
15% (vs. 66%, 5.8%,and 9.8%, respectively, in 2013). During the APEC meeting, President
Xi and President Obama jointly announced that China will commit to reducing the level of
carbon dioxide emissions by 2030.
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2.
Economic Research
Ten questions about China
November 28, 2014
Chinas outbound direct investment (ODI) has grown rapidly in recent years. In 2007,
Chinas ODI was US$26.5 billion, much less than foreign direct investment (FDI) in China
at US$83.5 billion. In 2013, ODI increased to US$108 billion (exceeding US$100 billion
for the first time), slightly less than inbound FDI of US$118 billion (see Chart 29). Chinas
ODI may first exceed inbound foreign direct investment in 2015, we believe.
The faster growth in ODI vs. inbound FDI is a result of Chinas economic growth and
has government policy support. First, the government has eased restrictions on Chinese
companies overseas investment. In October 2014, the government announced that except
for some sensitive regions and sectors, all overseas investment (regardless of investment
amount) would shift to a registration-based system instead of an approval-based (requiring
ad-hoc registration in place of ex-ante approval). Second, China has signed 12 Free Trade
Agreements (FTAs) so far with its trading partners, most recently with Korea and Australia,
and has been actively pushing regional trade agreements (e.g., ASEAN+3, FTAAP). These
agreements should facilitate cross-border investment between China and counterparty
countries. Third, China played a critical role in the recent establishment of the BRICS
Development Bank and Asian Infrastructure Investment Bank (AIIB). It also announced
plans to establish a US$40 billion Silk Road Fund. The objective is to promote
infrastructure development in emerging markets. Despite a lack of details at the
implementation level, we believe China hopes to strengthen its economic ties with the rest
of the world and not only achieve a win-win outcome as infrastructure investment benefits
other countries growth outlooks, but also find potential overseas demand for Chinas
excess capacity.
Chinas overseas M&A activities underwent some changes in 2014. Comparing the top
10 overseas M&A deals by Chinese companies in 1H14 vs. 2013, we note three new
features. First, there is a rising tide of private firm participation. Among the top 10 deals
involving Chinese firms in 2013, nine were undertaken by central SOEs; only one deal was
done by a private company. In 1H14, only four of the top 10 deals were done by central
government administered SOEs (or central SOEs); private companies were involved in
three deals and the other three were taken by SOEs that are supervised and managed by
local governments (i.e., local SOEs). Second, the target sector has moved from
resource/commodity sectors to manufacturing and others. In 2013, seven of the top 10 deals
were in the mining sector. In 1H14, only three were in the mining sector, and the other
seven deals covered the manufacturing (3), banking (1), real estate (1), wholesale & retail
trade (1), and IT (1) sectors. This suggests that the interest of Chinese companies has
broadened from resources to technology, market, and management. Third, the destination of
Chinas overseas investment activity also broadened to include not only resource-rich
developing markets, but also developed markets. The US is now the biggest recipient of
Chinese overseas investment.
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Ten questions about China
November 28, 2014
Outward direct
investment
Inward direct
investment
100
80
60
40
2008
2009
2010
2011
2012
2013
2014ytd
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Economic Research
Ten questions about China
November 28, 2014
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Economic Research
Ten questions about China
November 28, 2014
CNY60,000 to CNY100,000 (April 2014); and waiving VAT and sales tax for small and
micro enterprises, as well as individual industrial and commercial households, with
monthly sales revenue of less than CNY30,000 (September 2014).
The reform approach and next steps
The progress on fiscal reform in 2014 is encouraging. The three key areas include:
improving the budget management system, of which local government debt is the critical
issue; improving the tax system; and establish a new system that better aligns fiscal
spending with fiscal revenues (Question 5). We expect the first two issues to remain the
focus in 2015.
Regarding the budget management system, we look for progress in 2015 on including local
government debt in the budget management system. We also expect the quota for local
government debt issuance will be increased from CNY400 billion in 2014 to about CYN1
trillion in 2015. That jump implies there will be have to be a transitional arrangement to
avoid a fiscal cliff (Question 5). In our view, even with the issuance increase, local
governments will face stricter rules and funding constraints in financing new projects.
Regarding tax reform, we expect the VAT will be expanded to cover the whole service
sector. In addition, Congress likely will start the legal process to introduce a real estate tax,
although it may still take years before it is implemented at the national level.
(3) Administrative reform
Major reform measures announced in the past 12 months
Major reform measures include: (1) removing administrative approval items covering a
wide range of sectors such as financial, construction, tourism, transportation, etc.: on
August 12, the State Council exempted 45 more items from central government approval,
and most of these items were removed or reassigned to lower levels of government. Since
the new leadership took office in March 2013, the central government has cut or delegated
to lower governments nearly 400 administrative approval items (August 2014); (2)
simplifying the import management and administrative processes (September 2014); (3)
simplifying the pre-approval process for corporate investments, combining the pre-approval
and approval processes for projects and building up information-sharing as well as
regulatory platforms.
Overall, we believe the State Council is on pace to achieve Premier Lis target that about
one-third of existing administrative items should be removed during his term in 2013-2018.
This is an important part of the governments effort to let the market play a bigger role in
governing economic activity and allocating resources. Between March and August, 1.97
million new enterprises were registered, 61% higher compared to the same period last year.
Together with the tax cut measures for small and micro-size enterprises, it will help
generate employment, increase market competition, and support economic growth.
(4) Household registration reform and land reform
Major reform measures announced in the past 12 months
Major reform measures include: (1) on July 30, 2014, the State Council provided more
details on reform of the household registration (or hukou) system. The statement said that
small and mid-sized cities will remove residence restrictions; (2) on September 29, 2014,
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Economic Research
Ten questions about China
November 28, 2014
the Central Leading Group to Comprehensively Deepen Reforms (Chaired by President Xi)
reviewed and approved The Guide on Rural Land Contract and Management Rights
Transfer and Scale-Management in the Agriculture sector and The Pilot Reform Proposal
to Develop Joint Stock Cooperatives among Farmers and Shareholding Reform of
Entrusted Collective Assets; (3) on November 20, 2014, the State Council released
Opinions to Orderly Transfer of Rural Land Management Rights and to Develop Scale
Management in the Agriculture Sector.
The reform approach and next steps
Hukou reform and land reform are closely connected, as reforms related to land rights
(ownership, contractual rights and management rights) and their transferability are the key
issues for both. Recent proposals seem to lean in the direction of separating the two reforms
at this stage so as to avoid a deadlock.
The hukou reform proposal focuses on removing urban and non-urban household
registration requirements in small and mid-sized cities (i.e., cities with urban population
less than 1 million), and adopting a unified residence system. For non-residents, a residence
permit will be issued. However, it seems that the unified residence system will not
automatically lead to the equal treatment in the social safety net. In other words, we see
residence system reform as an intermediate step that first eliminated the difference in
hukou, but leaves unaddressed the more sensitive issue of equal social services. In large
cities, the hukou restriction will continue to exist in its current form for the foreseeable
future.
The near-term focus of land reform is to clarify land rights, which in our view is necessary
for more meaningful reform. The objective of land reform, in our interpretation, is to clarify
and stabilize land ownership and contractual rights, and allow for the transfer of
management rights. A pilot reform of management rights transfer will be implemented at
local levels in the next one to two years, but nationwide land reform may have to wait
several years before land rights clarification is completed. Land reform is perhaps the most
complicated and difficult task in the overall reform agenda.
(5) State-owned enterprise (SOE) reform
Major reform measures announced in the past 12 months
Major reform measures related to SOEs include: (1) on July 15, 2014, the State-Owned
Assets Supervision and Administration Commission of the State Council (SASAC)
announced that six centrally administered SOEs will pilot reforms in four areas: (i) capital
investment company restructuring, (ii) mixed-ownership economy, (iii) central board of
directors exercising senior management personnel selection, performance appraisal and
compensation management, (iv) supervised by Central Discipline Inspection Group; (2) on
August 27, the Political Bureau of the CPC Central Committee approved plans to reform
the compensation system that determines centrally administered SOE executives salaries
and the size of their expenditure accounts and other privileges; (3) after Shanghai first
announced 20 local level SOE reform measures in December last year, 20 other cities or
provinces (including Guangdong, Chongqing, Guizhou, and Hubei) put forward their
opinions on local SOE reforms, emphasizing mixed ownership.
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November 28, 2014
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November 28, 2014
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November 28, 2014
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