Keep an eye on data from the Asian giant and expect the unexpected

Each December, China's leaders meet to lay out their economic agenda for the next year. And each December, China-watchers pore over their every word, much like Kremlinologists during the Cold War.

It bears remembering that these pronouncements are rarely predictive, and that the best sources of insight on China's economy are usually found elsewhere.

Here are a few key points to keep in mind this year.

Watch the data, not the New Year's resolutions

At the end of 2015, China's leaders were touting plans for deleveraging and supply-side reform.


Now they're touting yet more plans for deleveraging and supply-side reform.

In between, total outstanding credit rose from 246 per cent of gross domestic product to about 265 per cent, according to Bloomberg Intelligence economist Tom Orlik.

Although reining in credit is essential for addressing many of China's economic problems, the government is still targeting 6.5 per cent growth this year, much of which will be reliant on yet more debt.

So pay less attention to the talk and more to the data -- specifically, metrics such as credit growth and real-estate prices.

Follow the Fed

China remains tied to the US economy, whether it wants to be or not.

Unfortunately, not everything that's good for the US is good for China.

With the US labour market tightening, and President-elect Donald Trump promising a US$1 trillion ($1.4t) economic stimulus, it is all but certain that the Federal Reserve will continue raising interest rates this year.

That could have some positive effects for China's real economy, but it will also put pressure on the People's Bank of China to raise its own interest rates or risk breaking the soft peg of the yuan to the US dollar.


Higher rates, in turn, would raise borrowing costs for heavily indebted Chinese companies, many of which could end up in bankruptcy.

How fast the US economy grows, and how many times the Fed raises rates, could have as much impact on China's economy as anything this year.

Politics matter

For a country that prizes stability, China faces a lot of political uncertainty this year.

An important question is whether Premier Li Keqiang will stay on for a second five-year term after the 19th National Congress, at which most of the Politburo Standing Committee is expected to retire.

Li, who plays a key role in economic policy making, had long been expected to remain paired with President Xi Jinping until 2022.

Yet Beijing is now buzzing with talk that Li will be replaced.

This would likely be a death knell for the free-market reforms that Li has championed, such as overhauling state-owned companies, and signal that the more centralised approach favoured by Xi will prevail.

Whether Li stays or goes should offer a lot of insight into China's economic future.

The cure can be worse than the disease

Rising asset prices in China have helped prop up everything from coal and steel firms to consumer sentiment. But with potential bubbles popping up everywhere, the government seems to be laying the groundwork for reform.

That could mean raising interest rates, applying new restrictions on trading or tightening other regulations. Remember that such measures, however necessary, carry risks of their own.

For example, given that China has some of the world's most expensive housing relative to income, and extremely low turnover, withdrawing credit could result in a real-estate price shock.

That might cause indebted developers to fail, or lead to much stronger government action to prevent a hard landing.

As regulators try to rein in other asset prices, watch for similar turmoil in bonds and the yuan.

Expect the unexpected

China has long been plagued by poor-quality data, with even senior leadership expressing frustration at getting inaccurate information from the provinces.

Unreliable data makes it nearly impossible to properly assess risk, which raises the probability of some type of internal shock. It could come from the nearly US$4t market in murky wealth-management products.

It could come from social instability tied to hidden unemployment.

It could come from something totally unexpected: With the bond market in turmoil, liquidity concerns mounting and defaults rising, there are many ways in which a panic could materialise. And that raises a final note of caution for 2017. Remember that risk is probabilistic and not mechanistic.

As China's known risks accumulate, the probability of some unexpected event having an outsized impact also increases. In such circumstances, the biggest mistake one can make is to rely on past assumptions to predict the future.