As we wrote early yesterday when we summarized the outcome of the first day of China's National People's Congress (NPC), China failed to deliver any of the major stimulus programs the market was expecting.
As a reminder, this is what Goldman was expecting as late as this past Friday: upon rhetorically asking itself "at what level do we expect the government would set the official deficit target given that many market participants expect a level above 3% or even as high as 4%" to which Goldman said "given our expectation that local governments will be allowed to issue more bonds within the budget (RMB500 bn in 2015) and recent statements from senior policy makers, including the Minister of Finance Lou Jiwei, that a 3% "red line" for the deficit might not be applicable to China, we expect the official deficit ratio target will be modestly above 3%."
It was not and China revealed a 2016 budget deficit of 3.0% - the absolute minimum, and well below the whisper 4%. Worse, as Goldman notes, "after adjusting for fiscal stabilization fund and cross-year deposits/withdrawal from the general public budget account, the actual expenditure-revenue difference was already 3.5%."
So did China actually trim its deficit expectations? If so, expect a major risk off move in the commodity sector.
Furthermore, Goldman also said that "if the government intends to achieve a higher growth rate (it has been widely reported that the government may target a range of 6.5-7.0% yoy real GDP growth this year), more fiscal stimulus would also be needed, which we think would primarily be through more infrastructure investment." Sure enough, Premier Li announced a targeted growth rate of 6.5% to 7.0%, however he was very vague, on purpose, in the details of how China would achieve this growth aside from noting something about even more roads to nowhere, to wit: "we should also expand major infrastructure projects, with the aim of increasing the length of high-speed railways in service to 30,000 kilometres and linking more than 80 percent of big cities in China with high-speed railways, building or upgrading around 30,000 kilometres of expressways, and achieving full coverage of access to broadband networks in both urban and rural areas."
Will this tepid infrastructure play be enough to boost commodity prices, which have soared in recent weeks heading into the congress on hopes of a massive stimulus, only to see another water pistol, we will find out in a few short hours.
In the meantime, here is Goldman's Yu Song with a post-mortem of what actually happened in China over this much anticipated weekend.
NPC comment 1: Government Work Report sets 2016 economic targets
The annual National People's Congress (NPC) started yesterday (March 5) and will last until the 16th. Premier Li Keqiang announced 2016 economic targets in yesterday's morning session. The China People's Political Consultative Conference (CPPCC) started on March 3 and will run in parallel with the NPC but will conclude on the 13th.
These two conferences are not the venues for the government to make new policies. If anything, there is a tendency to refrain from any significant policy moves (such as exchange rate adjustment) which could potentially lead to market instability. However, these conferences are highly important for the market since more information on policy decisions already made will be released.
The Government Work Report is the report of the State Council to the congress.
It reviewed changes over the past year and set a number of economic targets for 2016:
GDP growth target to be in a range of 6.5%-7.0%. Last year, the target was around 7.0%. This year, we note the absence of the word 'around' in front of the range, suggesting the government's determination to maintain at least 6.5% growth. Put differently, with an around 7.0% target, getting a 6.9% growth - which was the actual growth last year - is totally consistent with the target. With a 6.5%-7.0% range, if growth falls to 6.4%, it will be viewed as technically out of range. This determination is mostly related to the commitment to double 2010 income level by 2020 and concerns about employment. Doubling income level by 2020 implies an annual growth target at 6.5% till 2020, which is above our estimate of potential growth under the assumption of modest reforms. Some skeptics may say this simply means there will be more data 'smoothing', but we believe there could be at least some modest additional policy easing which will impact real growth. We have already seen some signs of this change since the start of the year, even though some observers may have gone too far to expect an aggressive loosening with money and credit continuously on the upside significantly as it did in January. Having said that, although the government has many controls over the economy, it may not always reach the targets it set. In 1998 for example, after significant efforts to reach an 8% or above growth, actual growth fell modestly below the target to 7.8% and even this number led to controversies (because the government failed to deliver its growth target). Overall, we see modest upside risks to our reported GDP growth forecast and less so in terms of the alternative measures of growth. Should activity growth rebound after a period of weakness, we believe loosening will likely become less aggressive as it typically did in the past.
The CPI target was set at 3% as usual and hence contains no new information. As CPI has in fact been running at significantly below that level for an extended period of time, it is not normally a binding target. There will be some temporary acceleration in CPI inflation recently - we expect February CPI to exceed 2% and surprise the market on the upside. But even if it does come in at 2.4% (our February CPI forecast) which can be viewed as closer to the upper bound/target of 3%, we believe it is mostly driven by temporarily adverse weather conditions and hence will start to normalize from March. The only risk of a continuous rise in CPI inflation is if broad money and credit supply were to be maintained at January which we see as unlikely unless external demand falls as much as it did during the GFC. Even if it does, we believe chances of that kind of loosening on an going basis is very low. We see largely balanced risks to our 1.5% forecast for the whole year though 1Q data is likely to surprise on the upside.
The M2 target of 13% is higher than last year's 12%. But last year's target statement had an additional line that, when implementing policy actual growth rate can be modestly higher. As recent M2 growth has been running at around 13%, this target itself does not necessarily represent a looser monetary policy stance but more a continuation of the existing policy stance. This is also consistent with the recent RRR cut which sent a clear signal of loosening bias but not to the degree seen at this time last year (when RRR cuts were as large as 100bp).The government also set a total social financing (TSF) target (13%) for the first time, reflecting the rising perceived importance of this measure. In the past, the target on credit supply had been on the much narrower RMB loan metric. (Note that TSF is not exactly 'total' in the sense local bonds and some other new products are not included. If we adjust for the local government bond swap program, the growth rate will be higher at 15.3%.) As TSF has been running at slightly below 13% recently and M2 growth modestly above, these two targets together represent a broadly stable monetary policy. This will likely raise concerns about the continued wide gap between money/credit growth and GDP growth, but in the absence of faster domestic financial reform and/or capacity cuts, we believe it will help keep the economy closer to the growth target and reduce deflationary pressures in the short term.
Fiscal deficit: The 3% on-budget deficit is reported as a looser policy stance as it is up from the 2.3% budget deficit last year. However, after adjusting for fiscal stabilization fund and cross-year deposits/withdrawal from the general public budget account, the actual expenditure-revenue difference was already 3.5%. There is no detailed information on how this 3% target was derived in terms of fiscal stabilization fund or cross-year deposits/withdrawal, so we cannot be sure that this represents a net loosening of the on-budget deficit (until we receive more information on the full budget). Assuming those adjustments are the same as last year, this will imply a modestly larger fiscal deficit. The main fiscal loosening will likely still be mainly via quasi fiscal loosening done by policy banks.
What's also important is the strong emphasis on tax cuts as the main reason behind the larger deficit. We see this as a clear positive step which is a key component of the supply side reform. Achieving the goal of a significant net tax reduction is not something easy, as much of the expenditure side is inelastic. There is a risk that while some tax cuts, such as cuts to import duties of some consumer goods, are partially offset by the rise in effective tax burden in other areas, there could be more stringent tax collection at the local level. Nevertheless, we view the clear policy direction as a positive move.
The employment and unemployment targets (urban job creations more than 10 million and registered unemployment rate not higher than 4.5%, same as last year) had generally not been of much relevance in recent years despite slowing growth, mainly because the targets were set leniently in our view and the measures such as unemployment are not sensitive to economic fluctuations. Even back during the GFC, urban registered unemployment never exceeded 4.3%. Hence, we believe the unchanged targets will face limited challenges despite likely restructuring in the overcapacity industries which we estimate will lead to meaningful but not very large impacts on employment, especially over the slightly longer run.
There were no targets on trade for the first time in recent years (China customs also suggested the abandoning of trade growth target earlier in the year). Instead, there was only a statement on the desire to achieve faster growth than last year which was very low (-2.9% and -14.2% for exports and imports respectively). We believe this is a positive development as it suggests the government has formally recognized that foreign trade growth rate is not something the government can and should control. Unrealistic targets in the past sometimes led to adverse effects such as reported trade data distortion. We see this move as part of a process of de-targeting economic growth and there are likely to be more similar moves in the future, but the pace of change is likely to be slow.
The Government Work Report also stated the need to reduce overcapacity, reform SOEs, eliminate barriers to entry for monopolized industries, continue infrastructure construction, step up international cooperation, control pollution, reduce poverty, among others. The statement on exchange rate was a short standard party line. There was also no mentioning of the registration based stock listing and property prices.
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Finally, as we summarized yesterday, here is a full breakdown of all the empty and hollow promises China made yesterday, of which we are absolutely confident it will deliver on none at all:
- To target 2016 GDP growth of between 6.5 percent and 7 pct.
- To target 2016 CPI around 3 pct.
- To target 2016 M2 growth target around 13 pct.
- Sees 2016 budget deficit at 3 pct of GDP.
- To use various monetary policy tools to maintain reasonable liquidity.
- To continue to implement prudent monetary policy.
- To continue to implement proactive fiscal policy.
- Will keep renminbi exchange rate basically stable in 2016.
- Will continue to improve yuan exchange rate regime in 2016.
- To deepen reform of financial sector.
- To further liberalise interest rates.
- To deepen reform of state owned commercial banks.
- To reform stock and bond markets.
- To promote sound development of multi-level capital market.
- To crack down on unlawful activities in the securities and future markets.
- To ensure no systemic or regional financial risks arise.
- To strengthen unified macroprudential management of foreign debt.
- To launch Shenzhen-Hong Kong stock connect pilot at appropriate time.
- To establish catastrophe insurance system.
- To develop internet finance.
- To develop inclusive and green finance.
- To insure proportion of direct financing is increased.
- To develop private banks.
- Sees growth in outstanding social financing of around 13 pct in 2016.
- To launch trial allowing commercial banks to participate in debt equity investment for small businesses.
- To establish standard financing mechanisms for local governments to issue debt.
- Says China to issue 400 billion yuan of special local government debt in 2016.
- To keep urban registered jobless rate below 4.5 pct in 2016.
- Will create 10 million new jobs in 2016.
- Will quicken supply-side structural reform.
- Will appropriately deal with zombie firms in 2016.
- To address issue of zombie firms using mergers, reorganizations, bankruptcies and debt restructurings.
- Will push ahead with reform of state-owned firms.
- Says will resolve overcapacity in industry, focus on steel and coal.
- Says 100 billion yuan in subsidies will be used primarily to resettle laid off employees.
- Says convinced Hong Kong, Macao will maintain long-term prosperity and stability.
- Says will oppose Taiwan independence separatist activities.
- Says will safeguard peace and stability in Taiwan Strait.