While Chinese economic growth is likely to stabilise in the near term, 2016 will likely be an even more challenging year for policymakers than that experienced in 2015.
That’s the view of Deutsche Bank’s China economics team, consisting of Zhiwei Zhang, Linan Liu, Yuliang Chang, Perry Kojodjojo and Colin Tan, who believe that recent policy easing announced by authorities to boost growth will only exacerbate overcapacity and raise leverage in the financial system, leading to damaging consequences over the longer term.
In the near term, the Deutsche believes that economic growth is likely to stabilise on the back of a rebound in land auctions, temporarily lifting fiscal revenues along with property and infrastructure investment.
The economic difficulty that troubled China for most of 2015 may be arrested temporarily in Q1. The difficulty in 2015 was to some extent due to a large fiscal contraction caused by the decline of lands sales revenue in H1. Land auctions have rebounded strongly since mid 2015 because of policy easing. As growth of land sale revenue usually lags growth of land auctions by 1-2 quarters, the fiscal revenue has improved in Q4 2015 and will rebound further in Q1 2016. This will likely help GDP growth to pick up in Q4 and Q1.
Investment is still the channel to boost growth, in our view. Higher land sales in Q3 2015 indicate the weak property investment may finally show some signs of stabilization in Q4 and Q1. Growth of infrastructure investment may pick up again as land sales helps boost fiscal revenue. Property and infrastructure combined account for almost half of investment in China. Hence we expect investment growth may pick up modestly in Q4 2015 and Q1 2016.
While in their opinion, growth will stabilise over the current quarter, they believe that the rebound in land sales was primarily driven by policy easing rather than fundamentals, pointing to the chart below that reveals the massive, and growing, inventory of unsold floor space within China.
“This round of rebound in land sales helps to address economic and fiscal pressure in the short term, but will exacerbate the oversupply problem in the property sector,” the quintet wrote.
Along with adding to China’s property glut, largely in smaller tier three and four cities, they believe that recent policy easing has led to another undesirable outcome – a further increase in leverage.
“The growth of credit stock as measured by the total social financial picked up in Q3 to 12.5% yoy from 11.9% in Q2. Based on our estimate this is the first time it rebounded since 2014Q4,” says Deutsche.
“The rising leverage in the economy imposes financial risks. The authorities are clearly aware of this, but decided to focus on the short-term growth concern in H2 2015.”
Deutsche expect that recent policy easing will run out of steam in in the first half of 2015, placing further downward pressure on growth and, as a consequence, the need for additional policy easing.
It’s a vicious cycle, with short-term policy decisions bringing forward spending and investment to the detriment of longer-term growth prospects.
As Zhang, Liu, Chang, Kojodjojo and Tan note, “further policy easing clearly has its costs”.
Further policy easing clearly has its costs. The leverage ratio of the economy will likely rise further and imposes higher financial risks. Loosening of monetary policy may delay the resolution of “zombie companies” and overcapacity problem further. The benefit of short-term growth stabilization will come with pains in the longer term, and the tradeoff is becoming increasingly unfavorable.
Despite these concerns, Deutsche expect that policymakers will continue to loosen the monetary and fiscal taps in the year ahead.
On monetary front, they expect four reserve requirement ratio cuts in 2016. With inflation relatively low, they also suggest that the PBOC can cut benchmark interest rates if downward pressure on growth intensifies.
With total government debt currently around 39.6% of GDP, not including RMB 8.6 trillion debt of local government financing vehicles, they suggest there’s also room for additional fiscal support should it prove necessary.
While these will continue to support short-term growth prospects, where it leaves the longer-term growth trajectory for the Chinese economy is anything but certain, adding to fears over the outlook for global growth in the year’s ahead.
On recent evidence policy easing has merely boosted over-investment and leverage, rather than helping to implement much needed structural reforms for the broader Chinese economy.