China's focus on reform seen as hurting short-term appeal

Beijing is prioritising reforms, which is good news for its long term prospects but could reduce the nation's short term economic growth, and affect its appeal to equity investors.
China's focus on reform seen as hurting short-term appeal

Beijing may not set a gross domestic product (GDP) growth target for 2018 as it prioritises reform efforts and improving the country’s quality of growth. This is positive for the country’s long term prospects but could hurt investor sentiment over the near term, say experts.

During the 18th National Congress of the Communist Party of China (CPC) in 2012, China’s ruling party vowed to double the country’s 2010 GDP by 2020. But in the 19th Party Congress held in October this year, it did not mention GDP growth targets at all. There was also no mention of any such target during the subseuqent Central Economic Work Conference, which concluded on Wednesday (December 20).

This indicates that Beijing may not reveal a GDP growth rate target for 2018. The annual target is traditionally announced by at the National People's Congress, held in March each year, Xia Chun, chief research officer at Chinese wealth manager Noah Holdings, told AsianInvestor.

Instead of focusing on the rate of growth, the government will emphasise on quality of its economic growth, he added.

“Not setting the GDP growth target next year is a very smart thing to do, because then it (the Communist Party) can justify the number of reforms and the number of things that need to be done that will probably cause some [reduction in] GDP growth basis points," Karine Hirn, Hong Kong-based partner at East Capital, a fund house that specialises in emerging and frontier markets, told AsianInvestor. 

Reform over growth

Economic reform now sits at the top of Beijing's top agenda. The word "reform" was mentioned 69 times in the working report delivered by Chinese president Xi Jinping at the beginning of the party congress, while "growth" was only mentioned 17 times.

Reform goals include changes to China’s financial rules to rein in shadow banking activities, deleverage the economy, reduce regulatory arbitrage, open up its capital market and others. Supply-side reform, or state-owned enterprise reform, is important to cut the country’s industrial overcapacity.

The Party has has other reform plans too, including tackling environment degradation and air pollution. Pursuing all of these are likely to prove a drag on economic growth, at least over the short to medium term.

“If (Beijing) says ‘we need to focus on deleveraging’ … and at the same time [it] says ‘we also want to have the GDP growth target’, it makes no sense. [It] can’t have both,” Hirn of East Capital said, adding that without a GDP target authorities can be “less compromising” on the reform agenda.

The World Bank has estimated China's GDP will grow at 6.4% in 2018. "Less accommodative monetary policy, stricter financial sector regulation and the government’s continuing efforts to restructure the economy and reign in credit growth are expected to contribute to this growth moderation." said a report from the multilateral institution, released on December 12.

That compares to China’s economy expansion of 6.9% for the first three quarters of 2017, according to country's National Bureau of Statistics. That was well above the 6.5% target that had been set for the year.

The emphasis on growth-limiting reforms are likely to affect foreign investors’ short-term sentiment on China as the economy’s expansion slows. But investors who have a longer term investment view on China will probably welcome the drive on reform, she added.

To realise the goal of doubling the 2010 GDP by 2020, the economy needs to expand by 6.3% every year between 2018 and 2020, UBS chief China economist Wang Tao said in a report earlier this month.

Following US rates

The Chinese government maintained its official tone of "proactive fiscal policy and prudent monetary policy" during the annual Central Economic Work Conference, according to a report by Bank of America Merrill Lynch (BAML) on December 20.

It also mentioned the need for monetary policy to "safeguard the [country’s] liquidity supply floodgate" and ensure reasonable credit growth, signaling continued tightening bias of the central bank, added BAML’ report.

As the US will likely increase its benchmark interest rate next year, China will have to follow suit or else capital outflow will worsen and the yuan will come under pressure to depreciate, Xia said.

The US proactively increases its interest rate as its economy improves, to prevent overheating and inflation. Corporates will see their borrowing costs rise but that should be offset by even higher revenue growth, helping the US equity market to perform well, he said.

However, China’s interest rate hike will be more passive. Liquidity conditions in the country will continue to be relatively tight, which could well weigh on A-share market performance, Xia noted.

MSCI equity fillip

Hirn of East Capital was more optimistic on the A-share’s market, arguing it could enjoy a fillip from being included into MSCI’s Emerging Market benchmark index next year. MSCI will include China A shares in its emerging-market indexes from June 2018.

The Shanghai Composite Index has risen 6.3% in the year-to-December 21 to 3,300, while the MSCI Emerging Markets Index is up by 31% during the same period.

In the initial phase of the A-share’s introduction into the MSCI index, 222 China A Large Cap stocks will be included. That will mean that shares 0.73% of the weight of the overall index. The 0.73% weighting for China will bring around $10 billion into mainland equities, Goldman Sachs estimated in mid-2017. 

Additionally, Hirn said she was confident that Beijing would take the “appropriate steps” and to keep the stock market stable in the first half of the year, and ensure a market crash does not take place. Hirn declined to offer a forecast on the A-share market's likely performance in 2018.

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