Looking back, we’ve been pessimistic since 2012.
China’s political reform has made little progress, which has hampered its economic restructuring.
As a result, the economic issues remain unresolved.
Macro economists have become unpopular, as they’re always pouring cold water and sending excessive negative messages.
However, the market is overall in a panic right now.
Is China’s economy and external situation much worse than in previous years?
First, the external markets, in particular developed markets, have undergone a thorough deleveraging process after the 2008 financial crisis.
Emerging markets also went through several currency devaluations.
Owing to the strength of the US dollar, commodity prices have come back down to earth, and hence, external markets are more flexible than in previous years.
Frankly speaking, China is the exception, and it has gone the opposite way by adding leverage since 2009, so the Chinese currency has kept rising.
That’s why we’ve been bearish since 2012.
The debt burden is mounting, while the financial system remains chaotic.
We’ve been looking for the right direction for China’s reforms during 2012 and 2013.
It is clear that Beijing needs to push for financial, state-owned-enterprise, land and fiscal and taxation reforms.
The market consensus is that we can’t accomplish these reforms overnight.
But the capital market has been overly optimistic about China’s reform.
In fact, we believe China has already made some progress in its reforms, albeit at slow pace.
Beijing should start overhauling the financial system.
The “credit crunch” in 2013 resulted in stubbornly high front-end interest rates and lower back-end rates despite the lack of overwhelming pessimism over economic fundamentals and the strength of the renminbi.
That was because of the country’s internal financial system, which has chaotic front-end and back-end risk premiums in the banking sector.
Risks have been accumulated in the shadow banking system, and problematic local government financing vehicles and property investment have made up a significant part of the domestic banks’ interbank business.
China’s financial system arrived at a critical moment in the first half of 2013.
Nearly three years later, front-end interest rates have fallen back as a result of various regulations.
And the Chinese central bank has achieved control over the interest rate spread.
China’s policy-driven financing has played a big role.
We coined the term “0.5 market” last year, which refers to the market between the Chinese government and the financial markets.
This market segment benefits from Beijing’s pro-growth policy incentives and also enjoys market options.
It can leverage national credit, and the central government would bear the heavy economic burden, in an attempt to gradually lower the operating costs for the real economy.
The initiative started with the China Development Bank and Agricultural Development Bank of China, and expanded to four state-owned banks.
It will late expand to other big commercial banks.
Meanwhile, deleveraging has already taken effect in some traditional and cyclical sectors, such as steel, cement, electrolytic aluminum and coal.
And the supply side has actively reduced supply, which has pushed prices up modestly.
Economic restructuring is a painful process.
The three provinces in northeast China and Shanxi province have been hurt badly.
In the first half of this year, Liaoning province and Shanxi ranked at the bottom in economic growth, and both have witnessed severe economic deterioration.
However, we’ve also seen some positive signs in Chongqing and Zhejiang province.
Take Zhejiang for example.
Hangzhou has been very successful in developing information technology and e-commerce over the last few years.
And the “No. 1 project” has achieved steady progress since last year.
As a result, Hangzhou and its neighboring cities have outperformed this year.
Chongqing has taken the lead for the second straight year, with 11 percent growth in gross domestic product in the first half of this year.
Cars and electronics have become the dominant industries there, and the financial and property sectors have played a bigger role.
A consumption-driven economy is starting to take shape in Chongqing.
And the city has also maintained high growth in infrastructure and property.
Shenzhen has also made huge progress in its economic restructuring in recent years.
China has a strong advantage in the consumption sector, stemming from its demographic structure and consumption habits.
That’s why consumption has maintained a growth rate of over 10 percent a year despite moderating overall growth.
China’s “talent dividend” has just started to flow, even as the “population dividend” has been fading out.
Traditional infrastructure projects that absorb low-end labor will come to an end.
The “one belt, one road” strategy, upgrading of traditional manufacturing, environmental protection, new electronic industries and so on will generate demand for talent.
China has laid a solid foundation after nearly 20 years of expanding access to college education.
This article, published in the Hong Kong Economic Journal on Sept. 9, was contributed by Lu Ting, chief economist at Huatai Securities.
Translation by Julie Zhu
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