Via Westpac comes a nice wrap of the Chinese base case:
China’s 2019 National People’s Congress has come at a pivotal time for the nation as authorities continue their pursuit of quality growth amid considerable global economic and financial instability. Because of both factors, China’s growth target of 6.0%–6.5% for 2019 is lower and wider than 2018’s ‘around 6.5%’.
If achieved, such an outcome would be a strong result for China. The growth target is high enough to support authorities’ long-term development ambitions. However, it is not too strong that it necessitates aggressive stimulus and/or a rapid increase in debt across the economy to be achieved. Instead of debt, central to the initiatives announced at the 2019 NPC is income.
2019 economic reforms
Particularly notable in the Government Work Report for 2019 are reduced tax burdens for manufacturers (VAT reduced from 16% to 13%) and transportation, construction and other industry (VAT reduced from 10% to 9%). Further, from May, local governments are able to reduce employers’ pension contribution from 20% to 16% as part of broader reforms for the sector.
These new measures follow personal income tax cuts in 2018 and corporate tax cuts targeting small and medium-sized businesses in January 2019. Together the scale of announced tax reforms is circa RMB2trn, or 2% of GDP.
The intent here is to alleviate the tax burden of key industries at a time of stress, particularly for externally-focused firms. The consequence should be two-fold: (1) an immediate shoring-up of employment prospects; (2) and further out, the expansion of productive capacity.
To further support the development of new capacity and ready the economy for the future: State-owned Enterprise reform will continue to rid the economy of zombie firms; restrictions on foreign investment will be reduced; financing and market access equality for the public and private sector will be promoted; and technological development pursued. Eventually these reforms should result in higher incomes for households, through both wages and investment income.
Coincident to these ’big business’ reforms, education-attainment for all citizens, particularly those from rural locations, and the cost of connectivity for small businesses are also in focus – the latter seeing broadband and mobile internet costs reduced by 15–20%.
Highlighting clearly that quality is to remain the focus over cyclical momentum, general budget funding for local government investment in 2019 will only be increased at the margin – assuming risks to growth do not grow (see market’s section below). However, a significant increase in the local government bond issuance quota is in the offing, and land sale revenue growth will also continue to aid local authorities’ revenue.
This injection of funds will fuel strengthening infrastructure activity across the nation in 2019, while making sure that each and every project is justified by its merits – as investors have to be willing to buy and hold the bonds.
Arguably relying on market-based funding not only allows each project to be assessed, but also the inherent effectiveness of the local government authorities that are planning, developing and bringing the projects to successful completion.
Over time, this will limit the build-up of bad and doubtful debts across China, and skew new funding in favour of the most productive and well-managed regions.
While not a focus of the 2019 Work Report, the push for finance to be offered to the best credit/ growth opportunities is also applicable to public and private enterprise. The curtailment of troublesome forms of non-bank lending (trust and entrusted loans) and focus on bank loans and market issuance will limit risks to financial stability.
The LGB (local government bond) issuance quota for this year has been raised to CNY3.08trn, with CNY930bn in general LGBs (+12% y/y) and CNY2.15trn in special LGB (+59% y/y). The CNY800bn increase in the special LGB quota amounts to around 0.8% of expected nominal GDP. Allowing more special LGB issuance is consistent with the policy direction to support infrastructure.
Proceeds from LGB issuance will be complementary to the fiscal expansion, with the budget deficit marginally wider than last year’s. The Work Report said it had considered preserving policy room when they came up with the 2.8% budget deficit – which is seen by the market as conservative, hinting that there could be an extra budget should risks to growth rise further.
While the increased supply of LGBs may divert some funds away from CGBs (central China government bonds), we maintain a constructive view towards CGBs.
First, foreign inflows are likely to continue upon index inclusion. We believe there will be a potential USD150bn of index inclusion-induced flows into onshore bonds over a 20-month period. Most foreign investors – especially newcomers – may focus on CGBs before they become more familiar with credit products. Second, there may also be asset allocation into bonds among domestic investors as economic growth slows and an easing bias is maintained for monetary policy.
In the Work Report, Premier Li reiterated that monetary policy should be prudent, utilising a combination of tools to enhance policy transmission and to keep liquidity at appropriate, ample levels. However, Li went on to elaborate that in order to promote credit expansion, “quantitative and price tools including RRR and interest rates” should be used in a timely manner. The authorities likely view the monetary policy transmission from liquidity easing to bank deposit and lending rates as not ideal and, as such, a reduction in interest rates may be engineered via guidance lower in the Loan Prime Rate. A reduction in the rate on TMLF(targeted medium-term lending facility) – which is already 15bps below the MLF rate – may also come, as TMLF targets lending to smaller enterprises.
On exchange rate policy, the authorities are to continue to “keep RMB stable around appropriate equilibrium levels”. Yuan stability is defined with reference to equilibrium levels, and these levels are not static, in our view. In 2018, as USD/CNY traded in a range of more than 10%, the PBoC still described it as stable. A “stable yuan” does not automatically translate into RMB strength, and there will still be two-way fluctuations, as was emphasized again in the latest PBoC monetary policy report.
As such, if the RMB is part of a trade deal, and if it is nothing more than a vague reference to yuan stability, this is not too meaningful. On the other hand, it looks unrealistic to us to believe that China would accept any explicit clause putting down ranges for USD/CNY and/or incorporating a vigorous monitoring process. A rigid exchange rate policy would have wide implications on China’s multi-year FX reform process and the opening-up of the capital markets.