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China steps up reform to avoid transformation trap
By Standard Chartered Research |
June 20, 2012, Wednesday
|
Print Edition
Print Edition
AT our big events in Beijing and Shanghai this month, we asked some 250 of our China-based clients what they thought about growth and the Chinese yuan this year. Here are their thoughts, and some of ours.
After the government rolled out various growth policies in recent weeks, we asked clients when they thought their own companies would see a recovery. The dominant response in both Beijing and Shanghai was in September, this was later than we expected. The recovery will be gradual and will be somewhere between a "U" and an "L" shape.
There is talk that the authorities are taking steps to encourage credit growth to stimulate the economy. We look for June loan growth above 1 trillion yuan (US$159 billion) after relatively strong lending of 790 billion yuan in May. There may be some window-dressing in these numbers (it is mid-year, so banks need to show asset growth), but we believe the underlying upward trend is real.
If September seems late for the impact of stimulus to be felt, consider that one-quarter of respondents believed China's stimulus measures would have no impact at all. This pessimism reflects the restrained nature of the stimulus, the nerve-racking external environment, and the broadly shared sense that monetary policy has limited impact at this point. Some have even talked about China entering a "Liquidity trap" like the one in which the US (possibly) finds itself today or Japan did in the 1990s.
A little overdone
We think such talk is a little overdone - a liquidity trap occurs when nominal rates have hit their zero-bound and real rates cannot be brought down without unorthodox monetary policy (quantitative policy aimed at boosting inflation expectations). In contrast, nominal rates can be reduced in China today - indeed, we expect the People's Bank of China to cut twice in the second half. Moreover, today's higher real interest rates are not particularly suffocating - especially since medium-term inflation expectations are likely still well embedded.
The problem might be better described as a "no reform trap" than a liquidity trap. There are different versions of this problem. Scholars such as Cai Fang at the Chinese Academy of Social Sciences have outlined their fears of a "middle income trap." A fast period of growth creates a wealthy elite but not a middle class; this means there is no sustainable domestic demand. This idea was influential in the drafting of the 12th Five Year Plan. Others, such as Sun Liping, an influential sociologist at Tsinghua University, have talked about a similar "transformation trap" where the interest groups that profit from the half-transformed growth model derail meaningful reform.
Detailed regulations
The authorities are currently busy drafting detailed regulations to complement the broad "36 Articles" they issued in 2010. The "36 Articles" attempt to promote the private sector, particularly in power, rail, infrastructure, telecommunications, petrochemicals and financial services. Progress so far is limited. Sceptics point out that the private sector is being invited into infrastructure and rail at a time when financing is tight and the local governments that pay for such projects are heavily leveraged. Other critics point out that if these sectors are already full of large, politically connected, cash-rich but inefficient state firms, private companies will not be able to compete.
China is not facing a liquidity trap - the key disincentive to private-sector investment is state-sector dominance and regulatory barriers, both official and informal, to entry. Meaningful reform would involve the withdrawal of state-controlled firms from non-strategic sectors.
Recent moves in the yuan market have undermined onshore confidence in continued appreciation - and one-third of our clients now believe that the currency will be "a bit weaker" against the US dollar in a year's time. The majority still expect moderate yuan appreciation over this period, as we do, but confidence in this view has clearly eroded.
US dollar strength has induced Asian foreign exchange weakness in recent weeks, and the yuan has consistently weakened off the dollar/yuan daily fix in the second quarter; even more so since the band widening on May 16. The PBoC has kept the yuan fixing much more stable and stronger than spot, sending a clear signal to the market that it does not want the yuan to weaken more aggressively. We do not think the PBoC has intervened physically in the onshore foreign exchange market since April, but we believe it would do so if the yuan weakened more aggressively.
After the government rolled out various growth policies in recent weeks, we asked clients when they thought their own companies would see a recovery. The dominant response in both Beijing and Shanghai was in September, this was later than we expected. The recovery will be gradual and will be somewhere between a "U" and an "L" shape.
There is talk that the authorities are taking steps to encourage credit growth to stimulate the economy. We look for June loan growth above 1 trillion yuan (US$159 billion) after relatively strong lending of 790 billion yuan in May. There may be some window-dressing in these numbers (it is mid-year, so banks need to show asset growth), but we believe the underlying upward trend is real.
If September seems late for the impact of stimulus to be felt, consider that one-quarter of respondents believed China's stimulus measures would have no impact at all. This pessimism reflects the restrained nature of the stimulus, the nerve-racking external environment, and the broadly shared sense that monetary policy has limited impact at this point. Some have even talked about China entering a "Liquidity trap" like the one in which the US (possibly) finds itself today or Japan did in the 1990s.
A little overdone
We think such talk is a little overdone - a liquidity trap occurs when nominal rates have hit their zero-bound and real rates cannot be brought down without unorthodox monetary policy (quantitative policy aimed at boosting inflation expectations). In contrast, nominal rates can be reduced in China today - indeed, we expect the People's Bank of China to cut twice in the second half. Moreover, today's higher real interest rates are not particularly suffocating - especially since medium-term inflation expectations are likely still well embedded.
The problem might be better described as a "no reform trap" than a liquidity trap. There are different versions of this problem. Scholars such as Cai Fang at the Chinese Academy of Social Sciences have outlined their fears of a "middle income trap." A fast period of growth creates a wealthy elite but not a middle class; this means there is no sustainable domestic demand. This idea was influential in the drafting of the 12th Five Year Plan. Others, such as Sun Liping, an influential sociologist at Tsinghua University, have talked about a similar "transformation trap" where the interest groups that profit from the half-transformed growth model derail meaningful reform.
Detailed regulations
The authorities are currently busy drafting detailed regulations to complement the broad "36 Articles" they issued in 2010. The "36 Articles" attempt to promote the private sector, particularly in power, rail, infrastructure, telecommunications, petrochemicals and financial services. Progress so far is limited. Sceptics point out that the private sector is being invited into infrastructure and rail at a time when financing is tight and the local governments that pay for such projects are heavily leveraged. Other critics point out that if these sectors are already full of large, politically connected, cash-rich but inefficient state firms, private companies will not be able to compete.
China is not facing a liquidity trap - the key disincentive to private-sector investment is state-sector dominance and regulatory barriers, both official and informal, to entry. Meaningful reform would involve the withdrawal of state-controlled firms from non-strategic sectors.
Recent moves in the yuan market have undermined onshore confidence in continued appreciation - and one-third of our clients now believe that the currency will be "a bit weaker" against the US dollar in a year's time. The majority still expect moderate yuan appreciation over this period, as we do, but confidence in this view has clearly eroded.
US dollar strength has induced Asian foreign exchange weakness in recent weeks, and the yuan has consistently weakened off the dollar/yuan daily fix in the second quarter; even more so since the band widening on May 16. The PBoC has kept the yuan fixing much more stable and stronger than spot, sending a clear signal to the market that it does not want the yuan to weaken more aggressively. We do not think the PBoC has intervened physically in the onshore foreign exchange market since April, but we believe it would do so if the yuan weakened more aggressively.
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