CHINA AT A CROSSROADS: WHAT TO EXPECT FOR CHINA AND … on China... · 2015. 10. 14. · 2015 2015...

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CHINA AT A CROSSROADS: WHAT TO EXPECT FOR CHINA AND THE WORLD Alicia Garcia-Herrero, Chief Economist Asia-PAC Natixis

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ROADMAP TO PRESENTATION

1. What was the stage for China’s recent drama? • More challenging global environment • Fragile economy in transition • Incomplete and disputed reform

2. Key market events so far and underlying reasons

• Stock market collapse • RMB devaluation

3. What next?: Three scenarios in order of likelihood • Muddle through • Bazooka (without reform) • Reform boost

4. No matter what, China still key to the world

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1. Stage for China’s recent drama a) More challenging global environment

EM weaknesses Commodity bear cycle

Geopolitics

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1. FED finally turning to normalizing monetary policy after 8 years of massive easing Capital outflows from EM to be expected, including from China

NATIXIS’s call

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Fed rate (%)

Probability of Fed rate hike (rhs)* Fed rate (lhs)

Sources: Federal Reserve, CME Group FedWatch

* Probability as of 5th Oct 2015

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2. Abrupt end of commodity supercycle Although China should benefit, massive stockpiling and investment put China in difficult situation

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China’s long bet on oil

China Crude Oil Import (3m avg) (RHS)

Brent Crude Oil (LHS)

WTI Crude Oil (LHS)

Source: Bloomberg, Natixis

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3. EM already more important for China’s trade than US/Europe but no longer an engine

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97 99 01 03 05 07 09 11 13 15

Destinations of exports (share in %, 12MMA)

US EU EM Japan

Sources : Datastream

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4. Heightened geopolitical risk putting China at (an aggressive) corner

Asia and beyond splitting in two areas of influence: • US through TPP • China (bilateral FTAs with key Asian Partners and One Belt One Road Initiative)

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1. Stage for China’s recent drama: b) Fragile economic transition

China’s economy clearly slowing down faster than official statistics

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Slowdown in Chinese Economy

GDP YoY%

Steel, 3m avg YoY%

Electricity, 3m avg YOY%

Cement, 3m avg YoY%


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Transition to a consumption-based economy still far from completion

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Contribution of components to GDP

Others

Net exports

Investment

Consumption

Source: Datastream

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Investment increasingly less productive and more credit intensive

28%

13%

17%

14%

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30%

2002 - Jun 2014 Jun 2014 - Jul 2015

Average credit growth overtakes investment growth from 2014

Investment YoY%

Credit YoY%

Source: Datastream, PBoC, Natixis

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Leverage becomes the buzz word: mostly domestic debt but also external

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83 72

125 7 24

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Increasing Debt-to-GDP in China (%)

Government

Financial institutions

Non-financial corporate

Households

Source: McKinsey, Natixis

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282

2.1 7.4 28.2 Total debt ($ trillion)

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Source: BIS, Natixis

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China

China’s public sector (especially local governments) is accumulating debt faster than Japan

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Source : Bloomberg

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Nominal wage (YoY%)

Source : Datastream

China also lost a great amount of competitiveness because of USD appreciation and rapid wage growth

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1. Stage for China’s recent drama: c) Incomplete and disputed reform

• Key reason for the stalled economic transition is a delayed and disputed reform

• Xi-Jinping much awaited reform program not yet implemented

• Financial reform faster than other areas (specially SOE reform) • But for soft-power reasons more than economic ones (SDR basket

being the best example)

• SOE reform needed to reduce inefficient investment and excess capacity • Recent announcements focus on management (regaining control) but

no shift of control to private sector (less so foreign investors) • Corruption campaign not enough to introduce market forces

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2. Key market events and underlying reasons a) Stock market collapse

• Beijing engineered a bull market for several reasons • To help banks and corporates to raise equity (and reduce leverage) • Bring good news to a slowing economy

• Beijing also triggered the bust although unintended

• Margin financing had become a huge problem • More leverage rather than less!

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2. Key market events so far and underlying reasons a) Stock market collapse

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10-Jun 17-Jun 24-Jun 1-Jul 8-Jul 15-Jul 22-Jul 29-Jul 5-Aug 12-Aug 19-Aug 26-Aug

Shanghai Composite Index's major events

Sources : Natixis

June 27 PBoC cuts rates and RRR

June 29 State Pension Fund starts buying stocks

July 4 Brokerages set aside $19 billions to jack up SHCOMP

July 8 CSFC starts buying midcap stocks

July 20 $483 bn stock-support plan through CSFC

July 27 CSFC stops intervention temporarily

Aug 11 PBoC dropped the central parity of RMB against USD

Aug 24 CSFC stops intervention

Aug 25 PBoC announces interest rates and RRR cut

June 12 CSRC scraps margin financing The biggest government intervention in a stock market than one

can remember: USD 200 billion estimated to have been spent so far to prop it up

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The contagion effect from China’s stock market collapses have only increased over time

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ChinaHong Kong

AustraliaNew Zealand

SingaporeSouth Korea

TaiwanIndia

IndonesiaMalaysiaThailand

PhilippinesVietnam

BrazilRussia

South AfricaMexicoTurkey

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TaiwanIndia


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UKFrance

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ASIA

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US & Japan

Index value on 6 Jul is used for US Index as market is closed on 3 Jul.

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2. Key market events and underlying reasons a)RMB devaluation

• Official explanation for devaluing the fixing on August 11 was introducing exchange rate flexibility

• But RMB appreciation against the USD and horrible export data indicate that economic reasons are at the core of the decision

• We should, thus, expect more, especially if USD keeps on appreciating against other Asian currencies

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2. Key market events so far and underlying reasons b) RMB devaluation

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CNY major events

Source: Natixis

Sep 2005 China breaks Yuan’s peg from the USD with trading band of +/- 0.5%

Aug 2008 China repegs Yuan to USD due to global crisis

Dec 2007 US bashes China for undervaluing Yuan by 40%

Jun 2010 Yuan appreciation resumes due to Chinese economic boom

Apr 2012 Yuan trading band doubled to 1%

Aug 2015 PBoC sets Yuan central parity down 1.9%

Mar 2014 Yuan trading band doubled to 2%

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China’s devaluation translated nearly one-to-one to many Asian and EM currencies The recent EURO and JPY is a safe haven story (also related to possible delay in FED hike)

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CNHCNYHKDAUDNZDSGD

KRWTWD

INRIDR

MYRPHPTHBVNDRUBBRLZARTRY

MXNGBPEURCHFCADJPY

FX: 24 Aug 15

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CNHCNYHKDAUDNZDSGD

KRWTWD

INRIDR

MYRPHPTHBVNDRUBBRLZARTRY

MXNGBPEURCHFCADJPY

FX: 11 Aug 15


ASIA

Other EM

Europe

Canada & Japan

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3. What is next? a) Most likely: Muddle-through

• Chinese authorities too confused/confronted to react united and aggressively

• Some additional monetary easing and moderate depreciation coming

• But probably tighter controls on capital outflows and on the economy in general

• If finally able to tame market, still lower potential growth in medium term

• Rest of the world will be left without its biggest engine

• Markets will be bearish for quite long as long as China is concerned

• Fed may delay hikes if market continues in this mood

CH

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3. What is next? b) Somewhat likely: Bazooka

• The meager reaction to additional easing yesterday increases changes of a Bazooka

• Huge fiscal stimulus package as in 2008 coupled with a large RMB depreciation (20%)

• Growth should return but also public debt piling up (100% of GDP…)

• Rest of world temporarily enjoying China’s growth but wary about sustainability

• Immediate market recovery but no lasting confidence

• Currency war may become a reality, at least in Asia

• FED would go ahead with its strategy

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3. What is next? c) Least likely: Reform boost

• Reformists (Li Keqiang and Governor Zhou) win the current battle and finally carry out a comprehensive reform program

• Defaults to surge but tamed by sector consolidation and hopefully foreign investment (if China opens up to rest of world)

• Investment will collapse temporarily and so will growth

• Economy may recover not too long and transit towards consumption/services

• China’s potential growth lower than in the past but still high to continue to be THE engine of the global economy

• Rest of the world will benefit from a more sustainable China

• But also more competition from a more productive China

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What can these scenarios mean for Chinese growth in the medium/long term?

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2015 2016 2017 2018 2019 2020

Three Possible Scenarios

Bazooka

Muddle-through

Reform boost

Source: Natixis

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Still, even in the gloomiest scenario, China will continue to be the largest contribute to the global economy

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China (Muddle-through) China (Bazooka) China (Reform boost) India US

Contribution to world growth

Source: Natixis

(27%) (19%)

(10%) (14%)

Contribution to global growth in

USD trillion Change in 2015-2025

More Likely

(19%)

Size in

USD trillion in 2015

Neither US nor India can make for China’s lower growth : the world will need to adjust

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Thanks for your time

Questions welcome

CHINA AT A CROSSROADS: WHAT TO EXPECT FOR CHINA AND … on China... · 2015. 10. 14. · 2015 2015...

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