Drivers behind the change in China's macroeconomic policies

December 11, 2017 09:58
China's current policy tightening is aimed at lowering growth rates and restructuring, rather than reacting to stagflation. Photo: Reuters

Market participants have been watching closely how the "new era" referenced by President Xi Jinping at the 19th Party Congress will affect government policy. With a lesser emphasis on GDP growth target, does that mean the Chinese government is heading towards tightening?

The Chinese regulators have surprised the market by bringing forward a number of financial deleveraging policies post the Party Congress, including forbidding the practice of providing investors with implicit guarantees against investment losses for the wealth management products and suspending the license approval of online small loan lenders.

In consequence, the 10-year Treasury bond yield has risen to 4 percent from 3.6 percent since early October. Meanwhile, the central government has also enforced stronger regulations on Public-Private Partnership (PPP) projects, including the unusual suspension of subway construction in cities like Baotou and Hohhot. Fixed-asset investment growth dropped to 5.5 percent on a year-on-year basis in Q3, the lowest since 2000. Moreover, in a recent work conference, the Ministry of Housing and Urban-Rural Development and the People’s Bank of China emphasized that they will not relax housing curbs.

So what is the Chinese authorities' bottom line on economic growth? We believe the central government is quite content with the current close-to-7-percent GDP growth. There is room for the government to address some of the structural issues that emerged from the high-growth era under the backdrop of a synchronized global economic recovery, a mild domestic inflation, and a solid job market. Thus, the market may see more policy tightening in the next two to three quarters.

We expect the government to clamp down investment growth rate next year as infrastructure and property investments have been relying too heavily on financial leveraging. With manufacturing sector recording more than 20 percent profit growth, capital expenditure level would likely be maintained or accelerated next year. This also aligns with the Party Congress' overarching target of addressing "unbalanced and inadequate development". Overall, real GDP growth rate may drop to around 6.5 percent next year, with only slight probability of a significant drop.

In our view, inflation and exports will cap the scale of policy tightening. Across the domestic economy, household real income growth and consumption appetite will be at risk if CPI rises from the current 1.9 percent to the central bank’s target of 3 percent, diverting economic restructuring away from the mainline objective of upgrading people’s quality of life. Internationally, if trade war escalates and turns China’s export growth rate from the current 7-8 percent to recession, tighter macroeconomic policies would become necessary.

Nonetheless, the probability of seeing the above scenarios come to pass remains low. In the short-run, the equity market may see a correction in view of concern over tightening policy. We recommend a defensive investment strategy as we await the new opportunities.

Given the fact that the current policy tightening aims at lowering growth rates and restructuring rather than reacting to stagflation, we are bullish on the significant investment opportunities in the financial and manufacturing sectors next year. The former will benefit from monetary policy tightening while the latter, the investment cycle. On a relative basis, the implementation of structural reform will counteract the demand and business model derived from financial leverage. As a result, the property and technology sectors may face bigger policy risk next year.

– Contact us at [email protected]


Head of China equities, BlackRock, Inc.