An­a­lysts weigh in on ef­fects of re­form in 2014

While Bei­jing pushes for sweep­ing re­forms to en­sure long-term and sus­tain­able growth, econ­o­mists are wor­ried about the short-term neg­a­tive im­pact, Emma Dai re­ports from Hong Kong

China Daily (Canada) - - BUSINESS -

As the struc­tural re forms out - lined at the Third Plenum of the 18th Cen­tral Com­mit­tee of the Com­mu­nist Party of China in Novem­ber be­gin to un­fold, econ­o­mists in Hong Kong are ex­press­ing mixed feel­ings about the in­vest­ment en­vi­ron­ment on the main­land.

Al­though the re­forms, whose goal is a more sus­tain­able de­vel­op­ment model, are viewed as ul­ti­mately pos­i­tive for the Chi­nese econ­omy, this year may be too soon to see con­crete re­sults, many ex­perts said.

In­stead, the mar­ket is likely to see mod­i­fi­ca­tions, es­pe­cially in in­dus­tries plagued by over­ca­pac­ity, said Pu Yong­hao, re­gional chief in­vest­ment of­fi­cer at UBS AG.

“Al­though we are happy about the mes­sage sent out by the Third Ple­nary Ses­sion, one must be aware that, in the short to midterm, there is still much to be done to ad­dress China’s struc­tural prob­lems.”

“Short-term pres­sure on GDP growth is un­de­ni­able, as the new lead­er­ship has put struc­tural re­form at the top of its to-do list,” Pu said.

He added that while stock mar­ket fluc­tu­a­tion is sure to come, many sec­tors — es­pe­cially heav­ily pol­lut­ing ones — will be reshuf­fled.

“It has yet to af­fect the listed com­pa­nies, but smaller ones, such as tiny steel mills in the north­ern prov­inces, are shut­ting down.”

He cau­tioned that if the mar­ket is go­ing to play a “de­ci­sive” role in the econ­omy, as cited by the re­for­ma­tive plan, in­vestors should be aware that freer com­pe­ti­tion also can lead to neg­a­tive re­sults such as bank­ruptcy.

“We should be aware of the risks stemming from the re­form,” he cau­tioned.

The re­cent re­form blue­print has been called the bold­est pack­age of poli­cies seen in decades in China. On the eco­nomic front, it vows to re­duce the level of gov­ern­ment in­ter­ven­tion to let the mar­ket play a de­ci­sive role in the al­lo­ca­tion of re­sources. The plan also sets lib­er­al­iza­tion of in­ter­est rates, SOE re­form and ur­ban­iza­tion as key themes.

In a De­cem­ber re­port, Stan­dard Char­tered Bank Plc called 2014 a “make or break year” when it will be vi­tal for China’s new lead­er­ship, which as­sumed of­fice in March, to ef­fec­tively im­ple­ment the eco­nomic re­forms.

The bank fore­cast 7.4 per­cent real GDP growth in 2014 for the na­tion, with growth in the first half slightly stronger than in the trail­ing half.

But the re­port also stressed that “the net im­pact of re­form on short­term growth is tricky to call” as the Peo­ple’s Bank of China, the coun­try‘s cen­tral bank, be­gins its at­tempt to delever­age the econ­omy.

“We ex­pect bank loans to grow 11 per­cent in 2014 to 8.5 tril­lion yuan ($1.4 tril­lion), slow­ing from 14 per­cent growth in 2013,” the Stan­dard Char­tered re­port said.

Slow­down pres­sure

That echoes the fore­cast of UBS.

“We es­ti­mate that the growth rate of ag­gre­gate fi­nanc­ing to the real econ­omy will slow down grad­u­ally in 2014,” Pu said, adding that in the af­ter­math of the 4 tril­lion yuan stim­u­lus pack­age in 2008, credit has grown twice as fast as GDP in China.

“That leads to low ef­fi­ciency of credit and a bub­ble in var­i­ous in­dus­tries. So, there is room for the cen­tral bank to tighten credit.”

In the face of an as­set bub­ble and shadow bank­ing, the cen­tral bank cur­tailed fund­ing for the in­ter­bank lend­ing mar­ket, boost­ing the overnight Shang­hai of­fered rate was as high as 13 per­cent. Oth­er­wise, the rate is usu­ally in the rage of 2 to 3 per­cent.

Ear­lier in De­cem­ber, the bench­mark in­ter­bank rate soared again to above 8 per­cent,

“Non-bank credit growth is also likely to slow. To­tal credit growth is highly likely to re­main above nom­i­nal GDP growth, so 2014 will be a year of more grad­ual lever­ag­ing up. We ex­pect delever­ag­ing to kick in only in 2015-16.” adding ten­sion to the fi­nan­cial mar­ket. In re­sponse, the cen­tral bank in­jected more than 300 bil­lion yuan through short-term liq­uid­ity op­er­a­tions on Dec 20, fol­lowed by another 29 bil­lion yuan through a re­verse-re­pur­chase agree­ment on Dec 24.

As in­ter­bank rates de­clined, the PBOC can­celed the reg­u­lar seven-day re­verse-re­pur­chase op­er­a­tion on Dec 31.

But the cen­tral gov­ern­ment faces a dilemma in tam­ing run­away credit growth, as it could harm the econ­omy if it clamps down too fast or too hard.

“By and large, credit will be tight next year,” said Shen Ming­gao, head of China re­search for Citibank, which fore­casts a 7.3 per­cent GDP growth for the coun­try in 2014.

“The cost of cap­i­tal is al­ready ris­ing in China, and the trend is likely to con­tinue,” Shen said.

“There is pres­sure to rein in ris­ing in­fla­tion. There will also be cap­i­tal out­flow as the United States car­ries out its ta­per­ing plan. What’s more, if prop­erty prices keep go­ing up, it will pro­vide one more rea­son for the cen­tral bank to tighten the money sup­ply,” he said, adding that more ex­pen­sive loans will lead to lower mar­gin and smaller ap­petite for in­vest­ment, which in turn will trans­late to slower growth.

But he stressed that not all com­pa­nies will ex­pe­ri­ence tight liq­uid­ity, as cap­i­tal costs vary among sec­tors.

“When lo­cal gov­ern­ment and SOEs get credit, it’s harder for pri­vate sec­tors to ac­cess the re­source. The crowd­ing-out ef­fect is ob­vi­ous,” Shen said.

“But the in­vest­ment ef­fi­ciency of SOEs and lo­cal gov­ern­ments is low. So the key to sus­tain­able growth is whether rem­nant as­sets can be liq­uidized by those who en­joy cheap fund­ing, and for those who are able to use it ef­fi­ciently. Only if the re­form is im­ple­mented can the liq­uid­ity prob­lem be solved and the cap­i­tal costs for pri­vate sec­tors de­cline.”

Ac­cord­ing to Pu with UBS: “Poli­cies will sup­port the struc­tural re­form. In the fu­ture, it will be harder for in­dus­tries that fall out of fa­vor to get credit.”

Find­ing a bright side

While the struc­tural re­form and tight­ened credit are clearly short-term neg­a­tives, there are fac­tors worth notic­ing on the bright side, as well.

“China is on its way up in the eco­nomic cy­cle, which is pos­i­tive in terms of in­vest­ment en­vi­ron­ment,” said Chi Lo, Greater China se­nior strate­gist of BNP Paribas In­vest­ment Part­ners.

“Var­i­ous data from power con­sump­tion and lo­gis­tics records to car sales all show that the re­cov­ery is steady and that growth is vi­brant,” he said, adding, “It’s a good sign for in­vestors.”

The bank ex­pects China’s GDP growth rate to be in the 7.5-to-8-per­cent range in 2014.

“Al­though down­ward pres­sure is likely to con­tinue for A shares, there will be ups and downs dur­ing the year, and that’s where the in­vest­ment op­por­tu­ni­ties lie,” said Lo. “In­stead of ben­e­fit­ing from a gen­eral mar­ket uptick, it’s crit­i­cal to choose the right sec­tors and the right com­pa­nies in 2014.”

Ac­cord­ing to Lo, non­bank­ing fi­nan­cial in­sti­tu­tions such as bro­kers and insurance com­pa­nies may also stand to ben­e­fit in the short term, es­pe­cially those do­ing cross-bor­der yuan busi­ness. The green eco­nomic sec­tor also will gain as the au­thor­i­ties fo­cus on high­qual­ity GDP.

And while the lux­ury sec­tor will con­tinue to un­der­per­form, due to gov­ern­men­tal crack­downs on cor­rup­tion, do­mes­tic con­sumer in­dus­tries, such as tourism and ed­u­ca­tion, are likely to see in­vestors flock to them, he said.

At the same time, Citibank’s Shen pointed out that in­stead of the GDP growth rate, in­vestors are more con­cerned with up­com­ing de­tails of the re­form and how the au­thor­i­ties are go­ing to im­ple­ment them.

“The Chi­nese econ­omy grew fast in the last two years, but the A shares didn’t per­form. Now, all eyes are on whether the re­forms will be able to boost mar­ket con­fi­dence,” said Shen, adding that in­vestors be­lieve that as long as the re­forms suc­cess­fully lift mar­ket sen­ti­ment, stocks will gain even with a lower GDP growth rate.

“The re­forms can lead to mar­ket sen­ti­ment nor­mal­iza­tion,” he said. “Cur­rently, the price-to-earn­ings ra­tio of China’s bank­ing sec­tor stands at around 5.6, which is ex­tremely low com­pared with an av­er­age of 10 to 12 in other emerg­ing mar­kets, ex­cept Rus­sia.

“If there is a re-rat­ing, we ex­pect the bank­ing sec­tor’s P/E to rise to 7. The sec­tor, along with the cap­i­tal goods sec­tor, should boost the MSCI China In­dex by 20 per­cent by the end of 2014.” Con­tact the writer at em­madai@chi­nadai­lyhk.com

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