“You are too pessimistic about China,” an audience of global portfolio managers were told after estimating the renminbi would depreciate 3%-5%, or more, against the US dollar over the next 12 months.
The comment came from David Li Daokui, director at the Center for China in the World Economy, part of Tsinghua University, and a former member of the monetary policy committee at the People’s Bank of China.
Li’s address at Credit Suisse’s annual Asian investor conference in Hong Kong followed a series of votes taken by the 500-plus fund managers from around the world, who had just expressed a lack of confidence in the currency, and mixed or ambivalent views about China equities.
But Li cited three reasons for optimism for China, its reform program and its financial markets.
First, on a per capital basis, China’s economy is still only 20% the size of America’s. So there is plenty of room to play catch-up. Based on other economies from Asia and Latin America that had a similar per capita size relative to the US, Li said there is no reason why China can’t continue to grow its GDP at the 8% level per annum.
The current concerns around the economy exist because it is in year two of a three-year adjustment period. The old engine of growth, exports and property, are phasing to a new engine of urbanisation and private consumption, while the economy is also digesting the impact of the government’s $4 trillion stimulus package of 2009-2010.
Second, Li argued that fears over leverage and credit are overblown. He conceded leverage in China is high, at 250% of GDP, but that it needs to be considered alongside the nation’s 51% savings rate of gross national product, the highest in the world.
With both households and governments producing excess savings, which is then channeled into investment, investors should be comfortable. Li noted that the US is leveraged 200% versus its GDP but its national savings rate is only 15% of GNP, a much less favourable ratio.
This means China has room to work out local government or corporate defaults. Li said he has proposed to the central government that it issue more treasury bonds in order to finance and ringfence such situations. “I suggest the government use new bond issues to set up a fund for the purpose of local public debt workouts,” he said.
This should come in two phases. First, set up a fund (of about Rmb 500 billion) that can issue bonds to raise further assets for restructuring deals; second, announce in advance the procedures of how debt restructurings will take place and the order of preference among creditor types. Together this can create something akin to the US’ Chapter 11 bankruptcy code, Li said.
Third, reform is in full swing, Li said, due to Xi Jinping’s strong grasp of the presidency. He is conducting easier, more popular reforms now to galvanise political support for the more difficult ones, such as tackling state-owned enterprises, in the near future.
Li repeated claims from senior government officials, including premier Li Keqiang, that deposit interest rates will be freed within two years. He also said capital account liberalisation would be achieved, at least in some form, in three years – with this month’s widening of the renminbi’s trading band from 1% to 2% as the opening move. Other reforms slated include establishing deposit insurance and securitising the assets of commercial banks.
As reforms gather pace this year, Li said the renminbi will appreciate by 3%-5% over the course of the next 12 months.
He said there are several milestones that can be observed to measure the success of reform. One is how China handles necessary defaults among some overstretched provincial or municipal governments. He argued that, if the central government lends its credibility – and financial muscle – to this process, it can contain the fallout. Part of this should include allowing local governments to issue public debt on their own.
Another signpost will be the access of private capital to the new growth sectors of the economy, particularly urbanisation. If China creates viable public-private partnerships in financing infrastructure, for example, that will be a positive sign that reforms are working.
SOE reform is hardest, because of opposition from both SOE executives and workers, and from a variety of ministers and officials who benefit locally from SOE ties. But Li said the government wants to start by taking away monopoly status. He cited the oil industry as an obvious place to start – particularly because of corruption cases, which should help Xi make his political case. Eventually SOEs can be reformed as market-oriented companies whose shares are held by the Ministry of Finance, just as many Singaporean corporations are owned or partly held by its sovereign wealth funds.
One final gauge Li mentioned: monthly urban fixed-asset investment figures. Compiled by the National Bureau of Statistics, these have been slowing. Over 2013, urban fixed-asset investment grew by 19.6%, at Rmb43.7 trillion. But growth in January and February was slower, at only 17.9%. Li said if activity returns to trend, while inflation remains in check, it should be a sign that pro-urbanisation reforms are headed in the right direction.