Investment led recovery brings risk and reward

Raymond Yeung. Photo / Supplied

The wealth effect continues to benefit China's trade partners - including New Zealand which saw an increase in exports to China to NZ$12.3b in 2016, about 9 per cent higher than a year ago.

At the recent National People's Congress (NPC) meeting, the message was that China would deepen "supply-side structural reforms" already conveyed in last December's Central Economic Work Conference.

Though the Government will maintain a decent level of growth through proactive fiscal policy and prudent monetary policy, further emphasis will be placed on structural reforms, including executing capacity reduction, de-leveraging, reducing property inventory, lowering the cost of doing business, and remedying the weakness in some economic segments.

The ultimate goal is to help the economy transition from investment-led to consumption-led. Although China's efforts to mitigate credit expansion and uneven growth throughout the country aren't without risk, successfully implementing reforms is seen as essential to its longer-term economic stability - which is ultimately beneficial for trade partners such as New Zealand.

Balancing growth and reforms is a daunting task.

China's economic target continues to be very ambitious. Although the government aims to achieve GDP growth of about 6.5 per cent, a pace lower than last year's actual expansion of 6.7 per cent, this still requires policy support, including a dose of fiscal policy.

Given an expected inflation target of 3 per cent, the value of GDP growth will be translated into a nominal expansion of CNY7 trillion in 2017, higher than the CNY5.5 trillion increment in nominal GDP in 2016. This means China needs to create the equivalent of more than five New Zealand economies this year.

Currently this growth target seems attainable. Recent economic sentiment has been upbeat, thanks to a noticeably strong investment in Q1. Fixed asset investment (FAI) rose 9 per cent year-on-year in the first two months, 0.8 percentage points higher than in December 2016. Infrastructure construction jumped 27 per cent, almost doubling the pace in the same period last year.

The momentum is expected to extend in 2017 with fixed asset investment planned by local governments being more than CNY50 trillion or about NZ$10 trillion. A strong investment pipeline will become a major driver for growth.

Property investment has also recovered rapidly in the first two months and registered growth of 9 per cent year-on-year, higher than the 2016 average by 2ppt. This suggests developers remain confident in China's real estate prospects despite the Government's efforts to cool property transactions.

Property investments in the central provinces have increased noticeably, while those in the eastern provinces lag behind. This development is not surprising as eastern provinces are where Tier 1 cities (like Beijing, Shanghai, Guangzhou and Shenzhen) are located. Nonetheless, faster growth of property investments in some provinces as opposed to others reflects the fact the impact of property tightening measures will be unlikely to turn the sector upside down.

Obviously, policymakers are concerned about housing bubbles, but they hesitate to curb real estate on a national basis. In March alone, about 20 cities or counties in China have announced property cooling measures. The number of cities imposing restrictions have also expanded from Tier 1 and top Tier 2 cities to lower-tier cities, and even counties that are near top-tier cities. But the policy actions are only city-based.

When China regains its growth momentum, it buys more from the rest of the world. In February, China's imports surged substantially by 38 per cent year-on-year, thanks to strong demand for commodities. As domestic demand recovers, commodity prices improve. Iron ore imports rose 13 per cent year-on-year in volume, extending gains from the previous month. The import prices of iron ore almost doubled on a year-on-year basis.

The strong import growth is in line with the improving import sub-index in the official PMI, which has moved higher through the first two months of 2017.

However, a major problem of the recent trend is that this investment-led growth model is inconsistent with the goal of taming credit growth and reducing corporate leverage.

Parallel to the strong investment in recent months is a rapid expansion of credit. New yuan loans pledged by Chinese banks increased by CNY3.2 trillion in the first two months of the year, an amount comparable to last year, suggesting that the first half of 2017 will likely repeat a property-driven recovery similar to that in the first half of 2016.

The reality is that the growth impact of additional credit is shrinking, and policymakers have yet to discover a solution to contain credit growth. At the NPC, the State Council continued to target an increase of total social financing by 12 per cent, higher than the growth of nominal GDP by 2.5 percentage points.

Unless China can suppress interest rates at a low level for an extended period (without fear of capital outflows), a high level of debt servicing will eventually drag down the country's disposable income -- and hence consumption -- representing a major obstacle to economic rebalancing in the long term.

On the positive side, credit growth does lend support to asset prices and the wealth effect bodes well for consumer spending, at least in the short term. As home prices increase, homeowners feel comfortable spending more. Our forecast is that of the 6.5 per cent of GDP growth in 2017, 4.9 percentage points will be contributed by consumption. Somehow, a property driven recovery and consumption growth can co-exist.

In fact, the wealth effect continues to benefit China's trade partners - including New Zealand which saw an increase in exports to China to NZ$12.3b in 2016, about 9 per cent higher than a year ago. Exports of dairy product rose from NZ$2.4b to NZ$2.7b, an increase of more than 10 per cent. This is significant given China's total imports from the world were up by just 3 per cent last year.

At ANZ, our core view remains that the rise of the middle class will continue to play a pivotal role in China's consumption and the fortunes of its trade partners.

This year, the Government is expected to support growth through a substantial increase in infrastructure spending, in order to secure economic stability. Undoubtedly, strong investment could arrest economic slowdown. But policy-makers will need to play this card carefully. It needs to avoid a pile-up of credit or risk the country's long-term sustainability.

Ultimately, China's domestic economic policy has a significant bearing on other countries. The world is interconnected, and whether China can successfully push forward its structural reforms is critical not only to China itself, but also its trade partners, including New Zealand.

- Raymond Yeung is Chief Economist Greater China, ANZ Bank