Premier Li Keqiang delivered his first government work report at the opening of the National People’s Congress (NPC) meeting last night. The new government promises to speed up reform, manage debt risks, fight pollution, and yet maintain 7.5% economic growth all at the same time but as SocGen'sWei Yao warns, this is going to be nothing if not challenging. Maybe mindful of a potential miss, Yao points out that policymakers seem to give themselves a small degree of flexibility by using new phrases like “a reasonable range for the growth rate” and “the growth target is
flexible”. Mission intractible or mission impossible?
Via SocGen's Wei Yao,
Premier Li sets himself a mission impossible
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In the meantime, financial system risk continues to intensify as we expected. On the night before the NPC meeting, China’s bond market saw the first ever default, as a solar company failed to service its debt. One of the reasons given for keeping the same growth target is to maintain market confidence. However, judging from the lack of performance of China’s stock market today, investors may well be focusing more on debt risk just like us.
Targets: little flexibility
In the 2014 Government Work Report, the GDP growth target is set again at 7.5%, the same as in 2013. However, the growth targets for fixed asset investment, industrial production and foreign trade are all lowered by 0.5ppt to 17.5%, 9.5% and 7.5%, respectively. The hope is for household consumption to step up, as retail sales are expected to grow at an unchanged targeted pace of 14.5% despite a big miss (13.1%) last year.
Besides, there is no change to the stated policy stance: prudent monetary policy and proactive fiscal policy. Broad money is again targeted to grow 13% and fiscal deficit is budgeted to widen to CNY 1.35tn from CNY 1.2tn in value, which is however estimated by the government at 2.1% of GDP – the same as in 2013.
Still somewhat different from the previous government, Premier Li mentioned several times that growth should be kept within “a reasonable range”, without specifying the range. He said that the upper bound of such a range is determined by inflation and the lower bound by unemployment. The government aims to keep the unemployment rate below 4.6%, while the latest reading is 4.1%. Given that, 7.5% looks more than enough. Furthermore, the work report from the National Development and Reform Committee (NDRC) – the planning agency – pointed out for the first time that there is some flexibility around the growth target. It seems that policymakers are still trying to give themselves some leeway.
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Reform dividend or drag?
In our view, the Chinese government really needs a lot more flexibility this year, given their reform promises. We agree that all the structural reform promised at the Party Plenum last November is good for China’s long-term prospects by sustaining potential productivity growth and mitigating tail risks. However, the reform dividend that Premier Li cited as one of the growth engines in 2014 may not materialise so quickly.
Going through the 2014 reform list (see below), we are pleased to see a number of concrete steps. To name a few, the language is quite firm on widening the yuan trading band, setting up a deposit insurance scheme, introducing a resolution mechanism for financial institutions, further deregulation, as well as opening banking, energy, infrastructure and telecommunication to private players. Deregulation and de-monopolisation are the only changes that we think may deliver positive impacts relatively soon, but it is not at all certain how much of a boost one can expect right away. At the same time, financial liberalisation entails higher financial market volatility in a time of rising debt risk.
The work report also devoted a section to “the war against pollution”, saying that the bad smog across China is a “red light” to the old growth model. The measures enlisted to fight this war include specific capacity reduction targets for a number of heavy industries and more marketdriven utility prices. None of these are exactly pro-growth.
Moreover, policymakers have not forgotten the local government debt problem. There are more details on how they plan to defuse the risk. The thinking is to increase formal local government bonds (LGBs) but to curtail growth of local government financing vehicles’ (LGFVs) borrowing. At the moment, outstanding LGBs amount to less than CNY 800bn, while LGFVs owe more than CNY 10tn to banks, bond investors and the shadow banking system. The central government plans to issue CNY 400bn LGBs on behalf of local governments this year, which represents an increase of CNY 50bn from 2013. In the case of a sharper-than-expected GDP deceleration, this will be far from enough to ensure acceleration in infrastructure investment growth.
First bond default
It seems to us a mission impossible to achieve each and every task outlined in the Premier’s speech without compromising on the growth target. In other words, in order to hit the growth target, debt risk will probably build further and/or reform progress may suffer. This is because the starting point for 2014 is more challenging than 2013 in two major aspects:
First, the property market is likely to become a drag on growth, instead of a boost as last year. Housing sales were booming in H1 2013, which supported a revival of construction and real estate investment in H2. Signs are mounting that housing markets in lower tier cities are cracking. If the government insists on delivering growth, it will have little choice but to resort to infrastructure investment and local government borrowing.
Second, financial risk is much heightened after another year of rapid credit growth. We have long argued that China’s financial market will finally see defaults in 2014. Just on the night before the NPC meeting, a solar-panel manufacturer informed its bond investors that it is unable to pay the CNY 90mn interest on its CNY1bn bond as scheduled on 7 March. Trust product defaults are most likely to be the next. Although we do not think that China will suffer a systemic financial crisis as a result, lower credit and investment growth seems inevitable as investors start to learn to price risk