Economy

Sun sees clouds ahead

China strategist outlines “balancing act” Beijing’s policymakers face

“Property prices will not come down” says Sun

With China’s Year of the Rabbit set to start in less than a fortnight it’s time to speculate on whether the new year will be a good one. Shanghai Daily reckons the rabbit is a lucky sign for Chinese markets, and adds that because 2011 is also a ‘metal’ year that’s a further positive, given it signifies wealth. However, for those less interested in horoscopes than hard data, HSBC’s China strategist, Steven Sun is a lot more cautious on the coming year. Here he offers his views on the challenges China faces:

Sun’s view on the year ahead:

It’s a politically sensitive year, given it marks the 90th anniversary of the Communist Party’s founding; and it’s also the first year of the new five year plan; and of course, there’s the leadership reshuffle next year. So you can be sure there are a lot of policy balancing acts going on. For example, if you are a central government policymaker you know you have to accommodate the growth desires of local provinces. The reason? The central government’s decision-making is increasingly consensus-driven and based on the views of the 300 people who are members of the Central Committee of the Chinese Communist Party. The majority of them come from the local levels of government, and these people have votes. So if you are a central government agency, you have to accommodate them. And they want their provinces and cities to have high growth.

That’s one side of this balancing act: growth. But given the inflation problem and the property bubble, we also know that the ordinary people on the street are not happy. They do not have votes, but the government knows if these problems get worse there could be huge social implications. So if you’re in the central government you need to balance their desires – for low inflation, lower property prices – with those of the local officials, who – like the property developers, and the big banks and the big state firms – all want high growth.

That’s a balancing act: a growth versus inflation dilemma.

On China’s tightening policy:

I believe economic policymakers are behind the curve in terms of tightening. The growth camp has the upper hand. That’s why in spite of hiking banks’ reserve ratios and raising interest rates, the central bank is still behind the curve. The reason I think this? Look at the interbank bond market where the yield curve has already picked up 100-130bp since November – and so far we’ve only had two 25bp interest rate hikes. That means you still have as much as 75bp of rate rises priced in. The bond market is telling you the People’s Bank of China still needs to tighten a lot: i.e. raise rates three times this year.

On Beijing’s track record of economic management:

Overall it does have a good record on balancing growth and inflation. But it’s hard, if not impossible, to forecast the future. What happened in 2008 is a good case in point. In the first half of that year the policy stance was to prevent inflation and overheating; only to find that industrial production almost collapsed because of the global financial crisis. In July 2008 the policy was quickly switched to promoting growth and then you had the big stimulus package in November. What this tells you is that Chinese policymakers are no different to policymakers elsewhere in the world: they don’t have the ability to forecast the future.

But the Chinese government is always very effective at stimulating the economy. On the way up, the interests of central government, local government and other vested interests are aligned. In 2009 the central government, for example, said we have to lend out no less than Rmb5 trillion and then boom, Rmb10 trillion got lent. Everyone was happy. On the opposite side, it’s always very challenging to manage the slowdown, because those same interests are not aligned. Central government wants to slow the economy down, but local governments, property developers and SOEs and other key groups all want growth. So on the way down it’s always more difficult and challenging.

For that reason, back in 2008 when no one believed China could achieve 8% growth, HSBC China economists were the first to say this was possible. I was the first person talking about the stock market rebounding massively in 2009. But as it became clear last year that the government had to slow the economy, for exactly the same reason that’s why I became the most bearish on the street. I forecast 2,800 for the Shanghai A-share index and it ended 2010 at 2,808.

On whether Year of the Rabbit will be good for China:

It will be an okay year. A good year suggests 20% upside for the markets. An okay year is 10%. This year I am still the most conservative index forecaster. For example, I am only looking for 3,000 by the end of the year, while most other strategists are talking about 4,000 at least.

On a property correction of 10-15% in the big cities:

I am not hoping for that. But what I said in my recent report is that if property prices correct 10-15% that’s a positive sign because it tells you the tightening policy has achieved its intended effect. The reality is the property price will not come down. It’s very difficult. The reason is because land transfer revenues are one third of local government revenue; last year land transfer revenues reached Rmb2.7 trillion. That’s an astonishing number and tells you that local governments have no interest whatsoever in killing their own revenue source. The local governments don’t want lower property prices. So that makes it a very complicated situation.

The difficulty of deflating the property bubble is one of the many reasons I am a bit more cautious in my outlook. China faces some difficult transitions as it moves to a consumption-led economy. Likewise it will find it tough to take on its own state monopolies to promote competition and to both liberalise interest rates and the exchange rate.

I also believe the reform phase has entered a critical phase. I said in my last report that the central government is finding it tough to push through key reform measures – precisely because China is now governed by consensus among the elite groups and there is no political strongman to single-handedly push through reforms. Big reforms were easier to deliver in the days of Mao, Deng and even Jiang Zemin. That’s no longer the case. For that reason I am not as optimistic as strategists at other firms about the smoothness of China’s economic transformation over the longer term.


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