Weekend Reads from China: What Investors Need to Know about the NPC Report

Amid rising doubts about China’s economy and the government’s ability to manage it, China’s annual parliamentary session of the National People’s Congress (NPC) kicked off last Saturday. There, Prime Minister Li Keqiang presented the government’s report on its economic targets for 2016.

Since the start of the year, China has experienced significant stock market turmoil and exchange rate volatility. Then, last month, a dire prediction of a hard landing was widely circulated. Recently the rating agency Moody’s cut its outlook on China’s sovereign bonds from stable to negative.

Amid all these developments, it is important for investors to understand the trends affecting China’s economy and the direction of its macro policies. Three points in particular need to be highlighted:

Maintaining Growth Remains a Top Priority

The government set the growth target for 2016 at between 6.5% and 7%, slightly lower than last year’s level of about 7%. A drop in the GDP target is a welcome sign, indicating that the government accepts lower growth. The range provided also implies the government will focus more on growth quality rather than the growth rate. Moreover, by setting 6.5% as the floor, the government delivered a strong signal that China will not allow a hard landing.

Another positive sign is that China didn’t set a target for exports. The adjustment of the exchange rate policy last August was understood as a competitive devaluation aimed at boosting exports. No target for exports this year suggests that this argument no longer holds water.

To meet the growth target, the fiscal deficit will increase to 3% of GDP, up somewhat from 2.3% in 2015. Despite that, fiscal support will be limited since the widening deficit mainly reflects slower growth in government revenue — the 2016 growth rate is 3%, half what it was in 2015 — as well as additional tax cuts and reforms. Monetary policy will continue to play an important role. M2 growth is set at 13% this year, almost double the pace of nominal GDP growth. These loose monetary conditions are good news for the bond market.

Infrastructure Investment Remains a Key Tool

Fixed asset investment (FAI), the growth of which was halved to 10% year-on-year in 2015, was the main drag on GDP growth. Most of the slowdown came from property investment, which rose only 2% in 2015. Meanwhile, infrastructure investment, up 17% in 2015, was the biggest driver of GDP growth.

Property investment will remain at low levels in 2016. Despite surging housing sales and higher prices in Tier-1 cities — including Beijing, Shanghai, Guangzhou, and Shenzhen — housing sales in Tier-3 and Tier-4 cities remain sluggish due to weak demand resulting from slower population inflows. Excess inventory will reduce new construction and investment in these cities, which account for about 70% of total construction and investment. Manufacturing investment, meanwhile, is unlikely to rebound due to overcapacity in many sectors.

Consequently, infrastructure becomes the only means of stabilizing investment. The government report emphasized its continued support for infrastructure spending, including funds for railroads, highways, irrigation, pipelines, etc., that will help spur development and growth.

The Reform of State-Owned Enterprises (SOEs) Will Progress

There is reason for optimism on the reform of SOEs thanks to both pressures and incentives from the government. Many SOEs are so-called zombie enterprises and have experienced diminishing profits and rising debt, which the government sees as increasingly unaffordable in the current environment. Reforms to the steel and coal industries, which have borne the brunt of the recent slowdown, augur well for further restructuring. Meanwhile, government subsidies to the laid-off workers have helped mitigate some of the human cost of these changes. The reform of SOEs will differentiate the healthy enterprises from the unhealthy ones, as the former will increase their market share while the latter will be eliminated.

In sum, China’s economy will continue to slow in 2016, but the possibility for a sharp decline is slim. There are still risks, however. Loose monetary policy means China’s debt will climb further. The closure of zombie enterprises will result in more bad loans and bond defaults. The depreciation pressure on the Renminbi (RMB) still lingers. How to balance the need to both stabilize the economy and avoid further financial risks will be a big challenge for China’s policymakers.

Below are some additional readings on the economic situation in China and across the globe.

More on China

• “Chinese Outflows ‘Not Driven by Capital Flight’” (Financial Times)
• “China’s Trilemma — And a Possible Solution” (The Brookings Institution)
• “Xi Jinping: A Cult of Personality?” (ChinaFile)
• “A Massive Threat to China’s Banks Is Building, and It Looks a Lot Like a Ponzi Scheme” (Business Insider)
• “Don’t Pay Too Much Attention to China’s Recent Trade Data” (Business Insider)

Emerging Markets

• “The Well Runs Dry” (Economist)
• “EM Fixed Income and FX: Enjoy the Calm” (Financial Times)
• “Globalisation Is Whimpering. Is EM to Blame?” (Financial Times)

Other Investing News from Around the Globe

• “Is Passive Investment Actively Hurting the Economy?” (The New Yorker)
• “A $10 Billion Hedge Fund Is Bracing for a 2008-Type Event” (Business Insider)
• “Here’s How Warren Buffett Views Risk” (Business Insider)
• “Wall Street Bonuses Fell 9% in 2015 to Average of $146,200 after Profits Decline” (The Guardian)
• “‘Brexit’ Fears May Hit London’s Property Market” (CNBC)
• “The Implications of Brexit for the Rest of the EU” (Vox)
• “Iron Ore Jumps by Record 19% on China Stimulus Hopes” (Financial Times)

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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