Examining China’s new era of macro policies

Tighter regulation, looser liquidity and fiscal consolidation are likely the new features of China’s macro policies

May 3, 2018 | Yi Hu

China’s macro policies have entered a new phase following the National People’s Congress meeting held in March 2018. Compared to the past few years, we at Invesco Fixed Income think China’s macro policies will feature tighter regulation, looser liquidity and fiscal consolidation. As previously communicated by President Xi Jinping and his administration, China is:

  • Changing its focus from “quantity” to “quality” of economic growth
  • Seeking to reduce leverage, lower financing costs and strengthen the manufacturing sector
  • Seeking to reduce major economic risks, especially those related to the financial sector and local government indebtedness
     

2018 policy objectives

The central government’s 2018 macro objectives are closely aligned with the above policy priorities. The government’s official 2018 growth target is around 6.5%, in line with 2017.1 However, the phrase of “striving for a better result” was erased from this year’s report. Growth targets for M2 and total social financing (TSF) — a broader measure of credit after equity financing is excluded — were removed, compared to 12% growth anticipated for each in last year’s government working report. In addition, the government’s fiscal deficit target was reduced to 2.6% of gross domestic product, from 3.0% last year.1 This marks the first time since 2012 that China has lowered its fiscal deficit target.

With monetary policy and financial stability set as “dual pillars” within the central bank’s new operating framework, recent personnel appointments at the People’s Bank of China (PBOC) are designed to enhance coordination between the two. Notably, Guo Shuqing, the Chairman and Party Secretary of the newly formed China Banking and Insurance Regulatory Commission, has also been appointed as the party secretary of the PBOC. Both Guo and new Central Bank Governor Yi Gang are expected to work closely with Vice Premier Liu He, who has emphasized the importance of financial regulation, especially counter-cyclical regulation during an economic upturn.

What could this mean for China?
Slower credit growth. Invesco Fixed Income expects credit growth to continue to slow and banks to gradually reduce off-balance sheet credit, returning to more traditional on-balance sheet lending. Regulations enacted since 2017 have aimed to reduce financial leverage and curb the shadow banking sector, which has been a source of debt expansion in China since the global financial crisis in 2008.
 

Moderating economic growth. Our forecast of 2018 growth is below consensus at the low 6% level. This is based on our expectation of further regulatory measures aimed at shadow banking and local government debt, state-owned enterprise deleveraging, and tighter policies related to the property market and retail loans. Resilient private sector consumption and a recovery in exports provide a growth buffer to China’s economy, but trade friction with the US has injected uncertainty into future export performance. Potentially lower fiscal revenue growth coupled with a lower deficit target indicates fewer plans to promote government infrastructure spending, in our view. This could put downward pressure on fixed asset investment growth this year.

Lower domestic interest rates. Recent regulatory tightening, especially related to interbank activities and non-bank financial institutions, has already encouraged participants to reduce financial leverage. Therefore, we believe the need for the PBOC to use short-term interest rates to curb leverage has been reduced. China’s mostly closed capital account and recent weak performance of the US dollar also allow the PBOC to act relatively independently of the US Federal Reserve rate hiking cycle. As such, we expect the PBOC to leave benchmark interest rates unchanged. This has led us to be more bullish than the market on Chinese onshore rates, and we see room for Chinese bond yields to trend down.

Currency cues from US dollar. Trade friction may complicate the performance of the renminbi, but it will likely continue to be driven by US dollar performance. If China’s trade surplus narrows due to greater US protectionism, it could put downward pressure on the renminbi. In contrast, a global risk-off episode that causes a sharp rise in the Japanese yen and euro versus the US dollar would likely cause the renminbi to appreciate. For now, we expect the renminbi to trade in its current range of 6.3 to 6.5.2

Conclusion
China’s changing set of macro policies points to potentially slower economic growth and strengthened financial oversight. Liquidity should remain sufficient, but weaker credits could experience tighter financing conditions. This leads to our overweight position in Chinese interest rates, neutral view on the currency and cautious stance on credit spreads of issuers with weaker credit profiles.

1 Source: HSBC Bank, China NPC: 2018 economic and policy targets, March 13, 2018.
2 Source: Bloomberg L.P., Jan. 1, 2018, to March 20, 2018.

 

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