Caixin View: Exclusive Briefing on China’s Economy and Finance

Contents

● The Week at a Glance

● Focus: the US-China “Trade War”

● Highlights this Week

● Fiscal Spending and Infrastructure Investment Looking Up

● Why the PBOC Only Hiked Rates 5 Basis Points

● Key Personnel Shifts

● Central Adjustment Fund to Help Struggling Pension System

● Upcoming Events Calendar

The Week at a Glance

First shots fired in trade war; China's response measured.

Market turns more bullish on fiscal spending and infrastructure investment.

PBOC hikes money-market rates, but just a little.

Key personnel changes

Details emerge of central government fund to ease provincial pension pain.

Focus: The US-China “Trade War”

Both Chinese and U.S. stocks plunged in response to increasing trade tensions between China and the U.S. Hours after Trump’s decision to slap punitive new tariffs on about $60 billion of Chinese goods, Beijing responded by unveiling a plan on March 23 targeting $3 billion worth of U.S. Imports.

China’s response has been relatively weak, said Lou Jiwei, the Chairman of the National Council of Social Security Fund, at the China Development Forum on March 24. If China really wanted to retaliate, he said, hitting U.S. exports of soybeans, automobiles and airplanes would be far more effective.

For trade wars, “the biggest effects by far are psychological,” said Larry Summers, President Emeritus at Harvard University and former U.S. Secretary of Treasury, also at the forum.

The economic impact of the latest U.S. move on China may be quite limited, say experts. As China’s reliance on exports is decreasing, the loss the U.S. tariffs may cause to the country is likely to be no more than 0.1% of the Asian nation’s GDP. China would also not be the only country to be hurt. For example, high-tech products are mostly likely to be targeted by the U.S. trade action. But many other countries are involved in various links of the production of such goods and China is just often the final exporter.

Fiscal Spending and Infrastructure Investment Looking Up

This week the market changed its bearish outlook for fiscal spending and infrastructure investment in 2018. Here are two reasons why.

First, before the National People's Congress, the market was braced for a tight fiscal policy stance. The budget deficit-to-GDP target unveiled was even lower than expectations, at 2.6%. But an increase in special bond programs for local governments and other funding means there will be more fiscal resources available, and, on a more broadly based calculation, a higher fiscal deficit.

Second, since the start of 2018, the market has assumed that a crackdown on local government debt and a shift towards quality rather than speed in terms of economic growth would put downward pressure on infrastructure spending. However, key drivers of the Chinese economy last year—commodity prices and exports—will likely wane in 2018, putting the pressure back on government led infrastructure spending to support growth.

Recent data also signals a proactive fiscal policy and increased infrastructure spending. Infrastructure investment-related fiscal spending rose 55.7% year on year in the first two months of 2018, while spending on agriculture increased 35.9% and spending on urban and rural community development projects jumped 23.7%, the highest growth rates for the January-February period since 2013.

Why the PBOC Only Hiked Rates 5 Basis Points

The People’s Bank of China (PBOC) hiked a short-term interbank interest rate by 5 basis points (0.05 percentage points) on Mar. 22, after the U.S. Fed raised the target range for the federal funds rate by 25 basis points to 1.5%-1.75%. Though the Chinese central bank’s hike was not a surprise, the change was smaller than expected, easing previous market concerns that the government may tighten its monetary policy.

The PBOC said in its statement that it raised interest rates to help control the country’s debt-to-GDP ratio. But the small margin of increase implies that the PBOC has no intention of tightening monetary policy much further. One of the reasons is that financial institutions have been contracting some of their business, such as shadow banking and interbank borrowing, due to a government crackdown. Consequently, signals of excessive tightening in monetary policy could increase systemic risks.

The funding costs of the non-financial sector have already risen and are weighing on the sustainability of the recent pick-up in economic growth. This should also discourage any efforts to tighten monetary policy further.

Separately, a strong yuan has given Chinese monetary authorities more leeway to adjust their policies according to the country's domestic conditions rather than continuing to lockstep with the U.S. Fed.

Key Personnel Shifts

Guo Shuqing, head of China's banking regulator (CBRC) and a prominent reform advocate, has been named chief of the new banking and insurance watchdog. The creation of this body, the China Banking and Insurance Regulatory Commission (CBIRC), was one of the most significant shifts in the government overhaul announced during the National People's Congress.

Liu Kun was named new minister of finance. Having working in both regional and central finance departments, he is expected to work on improving local governments’ fiscal discipline. China is stepping up efforts to make sure local authorities can no longer evade borrowing restrictions.

Liu He, a highly influential advisor to Xi Jinping, was named vice-premier. Seen as a chief architect of China’s latest economic reform strategy, Liu has been behind key policies such as the crackdown on financial risk, supply-side structural reform, and urbanization efforts.

Yi Gang was named as People’s Bank of China (PBOC) governor, as the first central bank governor to be educated abroad. Yi’s ascension strengthens China's image as a staunch supporter of globalization. The appointment of Yi, former PBOC head Zhou Xiaochuan’s old partner, signals continuity with Zhou’s long-term monetary and macroprudential policies.

Central Adjustment Fund to Help Struggling Pension System

At his annual press conference this week, Premier Li Keqiang gave details on a long-discussed “central adjustment fund” for the state pension system run by local governments. Admitting that some provinces were struggling to pay pensions on time and in full due to declining fiscal revenue, Li said that from this year, the central government will take 3% from each province’s annual pension fund income and redistribute the money to provinces who need funds to cover their pension obligations.

China is facing a pensions crisis: at the end of 2017, 240 million Chinese nationals were over 60. The state pension fund system is currently fragmented and managed by individual provinces. Some are struggling to fund their payment obligations, particularly those in the northeastern rustbelt — Heilongjiang province for example had a pension fund deficit of more than 23 billion yuan in 2016.

Transferring funds from provinces with high surpluses will help balance the burden. Three percent is a low start, but Li said this amount will increase. He also highlighted the potential of using state assets to replenish the social security fund. after a pilot scheme at end 2017 required several state-owned firms to transfer assets to provincial and central funds.

Upcoming Events Calendar

March 24-26: the China Development Forum (CDF) will be held in Beijing, with more than 60 top officials attending

March 25: the new governor of PBOC, Yi Gang, will give a speech on “financial policies within supply-side reform” at the CDF.

March 26: China’s crude oil futures will start trading at Shanghai International Energy Trading Center.

March 26: Data on market prices of key raw materials

March 31: NBS to release manufacturing PMI for March

About

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