China Economic Quarterly

Q3/November 2016 Major economic indicators p1/Policy updates p7/Hot topic analysis p9

China remains on track to grow in the third quarter of 2016 buoyed by service sector growth and fixed asset investment

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China Economic Quarterly Q3 20162

ContentI. Major economic indicators 1

II. Policy updates 7

III. Hot topic analysis 9

How successful is China’s supply-side structural reform? 9

China to roll out pilot programme on SOE reform 10

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I

Major economic indicators

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5

10

15

2016-Q1

2016-Q2

2016-Q3

2015-Q4

2015-Q3

2015-Q2

2015-Q1

2014-Q4

2014-Q3

2014-Q2

2014-Q1

2013-Q4

2013-Q3

2013-Q2

15.85

18.94

17.87

18.93

17.3416.61

14.79

17.86

16.3315.52

13.88

16.62

15.07

14.3

1.1%

1.5%

1.8% 1.8% 1.8%1.8%

1.4%

1.7%

1.9%

1.8%

1.7%1.6%

2.2%

1.7%

Quarter

Graph 1: Quarterly GDP and Seasonally Adjusted GDP Rate

China’s third quarter GDP exceeded market expectations with a growth rate of 6.7% or a total of RMB 53 trillion which went up 1.8% compared to the previous quarter, thanks to strong investment and expansionary monetary policies. In terms of sectors, services, which accounted for 52.8% of GDP, maintained its strong momentum, growing by 7.6% year-on-year in the first three quarters, contributing 58.5% of total GDP growth, resulting from double digit growth in investment. Meanwhile, primary and secondary industries experienced slower growth of 3.5% and 6.1% respectively. GDP growth rate could be around 6.7% for the whole year of 2016.

Source of data: Unless otherwise stated, financial data is from the People's Bank of China and economic data is from National Bureau of Statistics.

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Note: The primary sector is ‘agriculture’, the secondary sector is ‘construction and manufacturing’, the tertiary sector is ‘services’.

Graph 2: Sector Percentage in Quarterly GDP

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20%

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80%

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100%

2003-Q3

2004-Q3

2005-Q3

2006-Q3

2007-Q3

2008-Q3

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2010-Q3

2011-Q3

2012-Q3

2013-Q3

2014-Q3

2015-Q3

2016-Q3

Quarter

Primary Secondary Tertiary

11.3

%46

.3%

42.4

%

46.2

%42

.1%

47.4

%42

%

48.1

%42

.2%

47.6

%43

.3%

48.1

%42

.5%

46.4

%44

.7%

47.2

%44

.2%

47.2

%44

.3%

46.1

%45

.5%

44.6

%47

.2%

43.9

%48

.1%

41.7

%

50.4

%39

.5%

53%

11.7

%

10.6

%

9.7%

9.1%

9.4%

8.9%

8.6%

8.5%

8.4%

8.2%

8% 7.90

%

7.50

%

2 China Economic Quarterly Q3 2016

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For the first three quarters, fixed asset investment grew 8.2% (or 9.5% real growth rate) to RMB 42.69 trillion, and remained one of the key drivers of the overall economy. Though private investment comprised over 60% of total fixed asset investments, its growth rate remained low at only 2.5%. In contrast, state sector investment has offset the decline in private investment, increasing by 21.1%. Similar to overall GDP growth, investment in tertiary industry increased 11.1% and continued to dominate total fixed assets (57.62%) with a value of RMB 24.60 trillion.

Although the total investment in real estate only increased by 5.8% year-on-year (or 7.1% real growth rate) or RMB 7,460 billion, sales of residential buildings surged by 43.2% in response to new government restrictive policies on house purchase and land supply, and rising inflow of hot money into the market. As a result, the funds for developers reached RMB 10,471 billion, an increase of 15.5% over a year ago. Meanwhile, total sales of all commercial buildings reached RMB 8,021 billion, an increase of 41.3% year-on-year. Over-concentration of funds in the real estate sector has crowded out investment to the real economy and exerted more pressure on the housing bubble.

Meanwhile, China’s outbound direct investment jumped 53.7% year-on-year to RMB 882.78 billion (USD 134.22 billion) in the first three quarters. High-end manufacturing, information transmission and software technology services were hot areas for Chinese investment.

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Graph 4: Growth rates of investment in real estate development, land acquired by developers, and sources of funds for developers

Graph 3: Fixed Asset Investment: Accumulated Growth Rate

10%10.2%

Month

9.6%9.0%

8.1%

8.1%

8.2%

10.2%

10.2%

10.3%

10.9%

11.2%

11.4%

11.4%

13.5%13.9%

10.7%10.5%

2015-Feb2015-M

ar2015-Apr2015-M

ay2015-Jun

2015-Aug2015-Sep2015-O

ct2015-N

ov2015-D

ec2016-Feb2016-M

ar2016-Apr2016-M

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2015-Jul

2016-Jun2016-Jul2016-Aug2016-Sep

12%

-35

-30

-25

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-5

0

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20

2015/Jan-Sep2015/Jan-O

ct2015/Jan-N

ov2015/Jan-D

ec2016/Jan-Feb2016/Jan-M

ar2016/Jan-Apr2016/Jan-M

ay2016/Jan-Jun2016/Jan-Jul2016/Jan-Aug2016/Jan-Sep

(%)

-33.8

2.6

0.9

-33.8

2

1.3

-33.1

1.3

2.2

-31.7

1

2.6

-19.4

3

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14.7

-6.5

7.2

16.8

-5.9

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15.6

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15.3

-8.5

5.4

14.8

-6.1

5.8

15.5

Growth rate of land area purchased by real estate development enterprisesGrowth rate of sources of funds for developersGrowth rate of investment in real estate development

China Economic Quarterly Q3 20164

49.8%

49.9% 49.9%

50.1%

50.1%

50.2%

50.2%50%

49.7%

49.8%

49.8%

49.6%

49.7%

49.4%

49%

50.2%

50.4% 50.4%

50.1%

50.1%

50%

Month

2015-Jan2015-Feb2015-M

ar2015-Apr2015-M

ay2015-Jun

2015-Aug2015-Sep2015-O

ct2015-N

ov2015-D

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2016-Feb

2016-Jan

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2016-Apr2016-M

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2015-Jul

2016-Jun2016-Jul2016-Aug2016-Sep

Graph 5: Purchasing Managers’ Index

Graph 6: Growth rate of scaled industrial added value (month-on-month)

Month

6%6.1%

5.7%5.6%

6.2% 6.2%

6.8%

5.6%

5.9%

6.1%

6.8%

5.9%

5.4%

6.8%

6% 6% 6%

6.3%

6.1%

2015/Jan-Feb2015-M

ar2015-Apr2015-M

ay2015-Jun

2015-Aug2015-Sep2015-O

ct2015-N

ov2015-D

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ar2016-Apr2016-M

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2015-Jul

2016-Jun2016-Jul2016-Aug2016-Sep

Due to weak demand, overcapacity and rising debt, industrial added values grew by only 6% year-on-year in the first three quarters, compared with 6.1% for 2015, while industrial profits showed signs of recovery, rising 7.7% to RMB 577.1 billion in September.

Another encouraging development is Manufacturing Purchasing Managers’ Index (or PMI) moved to positive zone in the third quarter, with PMI for large-sized companies rising above the threshold between expansion and contraction to 52.6% in September while PMI for medium and small sized enterprises decreased slightly to 48.2% and 46.1% respectively. This shows that industrial growth remains fragile and may fluctuate further as the supply-side structural reform progresses.

On the topic of RMB, China has maintained an expansionary monetary policy to boost the economy. By the end of September, the balance of M2, broad money for deposits and money in circulation, reached a new high of RMB 152 trillion, rising 11.5% year-on-year. Banking loans increased by RMB 10.2 trillion in the first three quarters, which is RMB 255.8 billion more than in the same period last year.

Meanwhile, foreign exchange rate stood at RMB 6.68 against the US dollar by September, depreciating by 2.76% from the end of last year. Due to the prospect of interest rate rise by the Fed and slower growth of the Chinese economy, the RMB is expected to remain weak for the rest of the year.

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Graph 7: Retail Sales of Consumer Goods: Accumulated Growth Rate

10.7%

10.6%

10.4%

10.5%

10.6% 10.6%

10.7% 10.7%

10.2%

10.3% 10.3% 10.3%

10.2% 10.2%

10.4% 10.4%

10.5%

10.6%

10.4%

2015-Feb2015-M

ar2015-Apr2015-M

ay2015-Jun

2015-Aug2015-Sep2015-O

ct2015-N

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2015-Jul

2016-Jun2016-Jul2016-Aug2016-Sep

Month

Gro

wth

rat

e

China’s consumption continued its moderate growth in the first three quarters, contributing 71% to total GDP growth, 13% higher than a year ago. Total retail sales reached RMB 23.85 trillion in the third quarter, an increase of 10.4% (or real growth of 9.8%). We expect this trend to continue for the rest of 2016 and into 2017.

Specifically, catering went up 11.0%, retail 10.3%, and communication equipment by 12.7%. Thanks to rapid real estate growth, furniture sales increased by 13.9% and building and decoration materials enjoyed 15.4% growth. As before, e-commerce continued to reshape the retail sector. The online retail sales of physical goods, accounting for 11.7% of total retail sales, reached RMB 2,795 billion, an increase of 25.1% year-on-year.

International trade experienced negative growth again, as import and export shrank 2.3% and 1.6% respectively in the third quarter, but the decline is smaller than that of previous quarters. Total imports and exports declined by 8.2% and 7.5% respectively in the first three quarters. In tandem with other major trading nations, China’s imports and exports are very likely to witness continued contraction for the whole year of 2016 as the world economic recovery and global demand have remained sluggish.

China is still in transition from an export-led growth to a consumption-driven one. Yet it is significant that private enterprises have been dominating China’s international trade, accounting for 38.6% of total trade and 46.5% of exports.

Graph 8: Quarterly Balance of Trade

$0 Billion

$-20 Billion

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Import Growth

Net Export

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2013-Q2

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2015-Q2

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2016-Q2

2016-Q3

Quarter

Export Growth

Import Growth+Export Growth

-2% 6.2% 6.4% 4% -1.2% -4.1% -6.4%-3.1% 4.3% 7.2% 9.7% 2.8% -1.4% -4.8%-0.7% 8.3% 5.5% -2.4% -6.1% -7.6% -8.4%

12.1% 3.3% -9% 11.3% -13.8% -11.4% 2% -2.3%10% -0.3% -6.6% 15.3% -15% -3.7% 11.5% -1.6%

14.1% 7.4% -11.3% 7% -12.7% -20.4% -7.6% -1.9%

27.12 25.64 31.56 49.61 46.54 59.39 48.11

-0.88 15.21 7.71 30.94 3.08 60.34 29.86 25.85

China Economic Quarterly Q3 20166

Graph 9: Producer Price Index

-4.3%

-4.8%

-4.6%

-4.6%

-4.6%

-4.8%

-5.4%

-5.9%

-5.9%

-5.9%

-5.9%

-5.9%

-5.3%

-4.9%

-4.3%

-3.4%

-2.8%-2.6%

Month

2015-Jan2015-Feb2015-M

ar2015-Apr2015-M

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ct2015-N

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2016-Jan

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2016-Apr2016-M

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2015-Jul

2016-Jun2016-Jul2016-Aug2016-Sep

-1.7%

-0.8%

0.1%

After four and half years’ of negative growth, the Producer Price Index (or PPI) finally turned positive in September and grew by 0.1% thanks in large part to recovery of commodity prices. For the first three quarters, PPI declined 2.9%, which has led to the gradual easing of deflation for industrial products.

In the first three quarters of 2016, Consumer Price Index (CPI) increased by 2%, slightly higher than that of last year. Food prices rose by 5% in the same period, mainly caused by shortages of pork and vegetables. Prices for services, including healthcare, education and domestic services, have also increased due to strong market demand.

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China’s Communist Party General Secretary Xi Jinping stressed the role of the Party in the management of state-owned enterprises (SOEs) in a speech in mid-October. In Xi’s words, SOEs are “important political and material basis” of China’s socialism and “important pillar” of the party. These state firms and their leaders must remain absolutely loyal to the Party’s cause, as “a reliable force that the party and the nation can trust”. He also said the Party should be “embedded” into corporate governance, with Party officials playing a leading role in the policymaking, implementation and monitoring processes.

Stepping up party leadership in SOEs will allow the Party to play a more assertive role in ensuring its policies are faithfully followed and that corruptions are kept at bay. In the coming months, we expect the Party to increase its presence in SOEs through appointing reliable cadres to key corporate positions. It will also strengthen its hand in management by setting specific performance targets for senior executives. Meanwhile, we can expect SOEs to play a more active role in enforcing China’s strategic projects ranging from the Belt and Road initiative, Made in China 2025 to poverty reduction and low carbon growth. It remains to be seen, however, how the board of directors and the party will coordinate their positions to maintain consistency and continuity of corporate strategies and how the Party’s wishes are effectively aligned with the expectations of private investors under the mixed-ownership scheme.

II

Policy update

China Economic Quarterly Q3 20168

In addition to continuing to pour money into railway, recently, National Development and Reform Commission (NDRC) has expedited the approvals for urban rail projects, not only in provincial capitals and major economic cities, but also in third tier cities such as Baotou, an Inner Mongolia industrial city with a little more than 2 million population in northern China.

As a result, there are some 40 cities with new urban rail projects under construction, and 60 cities are going through planning, designing, and consulting processes for urban rail transit. Up to now, urban rail plans of nearly 50 cities have been approved with a total investment of more than RMB 2.5 trillion. For example, Beijing, Shanghai, Shenzhen, Chengdu, Suzhou and Qingdao received approval of urban rail investments of more than RMB 100 billion. The value of the projects of these six cities adds up to more than RMB 1 trillion.

Urban rail transit is just an example showing massive state owned investment in alleviating the economic downward pressure. Total infrastructure investment swelled by 19.4% in the first three quarters and reached RMB 8.3 trillion.

The State Council expects the fitness and recreation sector as part of sports industry to generate RMB 3 trillion business by 2025. Promoting consumption has been a priority of the Chinese government, who has recently announced a plan to further develop and nurture the fitness and recreation sector.

More specifically, the plan aims to promote fitness and recreation projects that are suitable for public participation such as football, basketball, fishing, and square dancing (a popular activity for senior Chinese in the early evenings). The government also plans to develop outdoor sports (including snow sports, mountain outdoor sports, water sports, car and motorcycle sports, air sports), specialty sports (e-sports, fencing, equestrian), and sports tourism.

China’s sports industry, accounting for only 0.1% of total GDP, relative to 2.5% for the United States, has huge potential for growth. There are many sectors similar to fitness and recreation which need to be further developed to meet consumer demand. Yet undertaking a market-oriented approach instead of heavy-handed government control would be the key to success for these sectors.

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IIIHow successful is China’s supply-side structural reform?

Hot topic analysis

Ever since President Xi Jinping proposed to shift attention of reform to the supply side last November, and it was subsequently adopted by the National People’s Congress in March 2016, supply-side structural reform (SSR) has become a buzzword used by Chinese leaders and a key component of China’s 13th Five Year Plan (2016-2020).

Partly triggered by the frenzied shopping of Chinese tourists during their overseas trips, SSR aims to address the root cause of the slowing economy by reducing non-effective and low-end supply and by boosting productivity through expanding medium-to high-end supply. This will hopefully promote the transformation from an export-and investment-led growth to a new one based on domestic consumption, services and innovation.

Overall, SSR will be a revolution of China’s existing economic system and its growth model. It calls for reducing overcapacity, destocking, deleveraging, reducing cost and shoring up weak growth areas. Its implementation will unavoidably cause some losses to economic growth while nurturing the long-term growth potentials.

To put things into perspective, SSR requires drastic actions in reducing industrial overcapacity, lowering business cost, phasing out “zombie enterprises”, creating a pro-innovation environment, developing strategic industries and service sector, and reforming the education, Hukou and labour movement systems. Breaking down administrative monopolies to unleash the vitality of the private sector and streamlining regulations and reducing government interference in enterprise operations are also important elements. Different from Reganomics or Thatcherism, it also calls for improving the levels of social security and individual income.

Among other commitments, the government has set the goal of reducing 100-150 million tonnes of crude steel production capacity by 2020 and phasing out 500 million tonnes of coal production in 3-5 years. Each central and regional government has been tasked to cascade and enforce its own action plans.

Based on official statistics for the first three quarters of 2016, China has made great strides in achieving these goals. Coal production for the whole country went down 10.5% over a year ago; inventories of industrial goods and housing declined; the average debt ratio for industrial companies fell 0.6% to 56.4%; emerging strategic industries such as information industry, new energy and new material expanded by 10.8%; and investment in environmental protection surged 43.4% year-on-year while energy intensity fell 5.2% and renewable energy consumption rose to 19.3%, 1.7% higher than a year ago. Meanwhile, the government will cut another 50 administrative approval items on top of 214 items that have been removed over the past two years.

Yet, it is still too early for China to claim victory. Old habits die hard, and changing government’s behaviour won’t be easy. Reliance on land sale remains high for many local governments to meet their budgetary needs. Some local governments are reluctant to get rid of the “zombie enterprises” out of fears of tax losses and social security issues. Recent improvement in steel and coal markets have sent some closed plants back into production, which further complicates the situation. Meanwhile, the government will have to tread carefully to keep a balance between SSR and the traditional proactive fiscal policy and expansionary monetary policy to keep the economy going. China still needs an annual GDP growth of 6.5% to achieve its goal of doubling its GDP by 2020.

It will be a bumpy ride.

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Marketing and Communications Cynara Tan Head of Marketing and Communications Asia Pacific

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Allan Zhang

Chief Economist

PwC China

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G. Bin ZhaoSenior Economist

PwC China

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Authors

These sectors are often regarded as the ones which have dramatic and significant influences on the livelihood and economic security of the public. In the past they were described by some as “untouchable” as far as alternative ownership models were concerned, so choosing these vital areas demonstrates the determination and confidence of the central government in promoting reforms.

As Liu explained, the goal of the reforms is to open competition among these businesses in order to break their administrative and market monopolies. Along with this, improving governance, strengthening incentive systems, having them focus on their main businesses, and promoting the competitiveness and efficiency of SOEs are the major objectives of the pilot reform program.

SOE reform might be the next major opportunity for an “economic revolution”. Unleashing their hidden vitality and improving their efficiency would serve as a focal point to reverse

About two weeks ago, Chinese President Xi Jinping called for strengthening and improving Communist Party of China (CPC) leadership over state-owned enterprises (SOEs) at a national meeting. He has sent a strong message that SOEs must deepen their reforms in order to “become important forces to implement Party decisions”.

SOEs have moved relatively slowly and have not yet made any remarkable or major progress on SOE reform, even though the Third Plenary Session of the 18th CPC Central Committee has drawn up a very ambitious blueprint. In June of this year the Central Leading Group for Inspection Work stressed to the State-owned Assets Supervision and Administration Commission (SASAC) that the expectations for SOE reform had not been met and called for SASAC to speed up the reforms. As a well-known scholar once pointed out, some of China’s SOEs, with their abundant financial resources and increasing power, had the tendency of becoming “independent empires”.

Mr. Liu He, a top economic advisor to President Xi, who is also the Director at the Central Leading Group for Financial and Economic Affairs of the CPC, recently urged the implementation of a pilot reform program for mixed ownership among some of the strategic and mostly SOE denominated industry sectors such as electric power, petroleum, natural gas, railways, civil aviation, telecommunications, and even defence.

China to roll out pilot programme on SOE reform

the economic downturn, while transforming China into a more advanced economy. According to SASAC, for the first half of 2016, gross revenues of both central and local SOEs (excluding financial companies such as banks, insurance, asset management and investment corporations) reached 21.39 trillion yuan, or more than 60% of China’s GDP for the same period. SOEs are usually much larger and have far more resources than their private counterparts. For example, among China’s 106 Fortune 500 largest companies, only a handful are privately owned.

We can expect that once SOE reforms have been launched and managed in a proper way, then China’s economy would continue to thrive and flourish for at least another two to three decades, creating enormous new business opportunities for foreign and local companies along the way.