22nd March 2013
China’s growth in the next decade is likely to be driven by a huge drive for urbanisation says Standard Life’s head of global strategy Andrew Milligan.
In a note issued on Friday, Milligan writes: “China has already announced plans to spend $6.4 trillion bringing 400 million people to cities over the next decade. Urbanisation is expected to climb to 53 per cent this year, and the Government hopes this figure will rise to 60 per cent by 2020. In light of the need for new homes, roads, hospitals and schools, it is no surprise that the urbanisation drive is increasingly seen as the main engine of growth over the next 10 years.”
However, Milligan can see some contradictions in the policy – first that is could lead to corruption, second whether it will really allow a reorientation towards a consumption-led model.
“Experience would suggest that a construction and infrastructure boom may have less favourable implications in terms of inequality and corruption. This explains why the government is increasingly vocal on the latter issues as they look to head off growing social tensions. Another pressing concern is how such a huge urbanisation programme would affect the economy’s supposed re-orientation to a consumption model – or are we back to more of the same in terms of investment-led growth?”
Milligan also notes that the recent handover with power being handed to two people from established ruling families creates its own barriers to change in China
He writes: “Family heirlooms are typically entrusted to those capable of preserving them for future generations. So when China’s outgoing leadership team officially handed over the reins of power at last week’s National People’s Congress (NPC) they doubtless assumed that the country was being left in safe hands. Certainly, from a political perspective the appointment of incoming leaders Xi Jinping and Li Keqiang reflects a focus on continuity and stability. Xi is the son of an illustrious party leader, and close to former president Jiang Zemin, while Li, a career bureaucrat with a PhD in economics, is a protégé of outgoing president Hu Jintao. Their roles as President and Prime Minister resemble a classic case of political yin and yang.”
“There may be a more fundamental reason why the reform process in China may disappoint in the near term. Unlike a democratic model, whereby an incoming party often makes rapid changes emboldened by a fresh mandate from the electorate, the Chinese political system places a greater emphasis on continuity and stability. A new president is often at his weakest at the beginning of his term, unlikely to want to alienate too many of established forces and using his time in office to build alliances and extend his power base. Conversely, the outgoing president is at the height of his power, having seen his personal network reach its zenith, with a legacy to protect.”
“The incoming leadership team is more than aware of this predicament. Li himself addressed the issue in perhaps the most telling of last week’s sound bites, ‘taking on vested interests now is harder than touching someone’s soul.’ If we are to expect the Xi-Li axis to defeat vested interests and change the direction of a Chinese economy they will clearly need to be more than just adept manipulators of the rather humdrum mechanisms of policy.”
Milligan notes that there is optimism about the economic reform programme but sounds some sour notes as well.
“This optimism has been fuelled by recent pledges to tackle inequality, boost urbanisation and deal with vested interests. In addition, much has been made of Xi’s pledge to rein in the state and promote greater efficiency in government. In reality, is this optimism well founded and can we expect a more progressive economic environment going forward?
“One source of encouragement is that some of the groundwork for economic reform has already begun. When the National Development and Reform Commission (NDRC) set its GDP growth target at 7.5 per cent early this month, it was greeted with none of the furore that surrounded the downgrading of the target to 7.5 per cent in 2012. That move helped manage expectations for a ‘lower growth’ environment for the foreseeable future, even if consensus forecasts for GDP growth in 2013 have since rebounded to 8.2 per cent. Of course, in reality these growth rates are largely symbolic and the more important issue lies in the quality, sustainability and make up of growth. A key issue is that investment spending is too high, accounting for about 50 per cent of GDP growth. While the government has reiterated its desire to shift to a more consumption-led model, this imbalance was top of the agenda at the start of Hu’s presidency in 2004 and progress has been rather slow.”
Shadow banking concerns
The notes points out other difficult areas including the railways and the shadow banking sector.
“One recent announcement that attracted attention was the decision to break-up the Ministry of Railways, a heavily indebted institution unduly associated with financial mismanagement. This change is expected to be part of a wider reform of the structure and purpose of government institutions, designed to streamline bureaucracy and boost efficiency. To achieve more far reaching change though a body charged with coordinating reform across ministries may be required.”
“Another potential limit on the reform ambitions of the new administration has emerged in the form of a surge in credit-dependent growth and the rapid development of the shadow banking sector. Total social financing is growing over 20 per cent a year. Until recently, the credit cycle was less of a concern than the housing market, which traditionally provided a warning light in the event of economic overheating. However, at the start of the year we saw a strong expansion in non-loan credit, mostly into small & medium property developers, construction and infrastructure companies. Many appear to be precisely the local government-oriented borrowers who were cut off in the last monetary tightening in 2010-11.”
“This boom in lending matches a surge in funding from the shadow banking sector, in the form of corporate bond issuance, trust loans and wealth management products. The worry here is that much of the lending activity is being carried out without appropriate assessments of default risks. This is certainly the case in the corporate debt market where the government has been active in intervening to support issuers when the prospect of payment difficulties has arisen. This has protected the integrity of the corporate bond market in general but has also created moral hazard issuers which may have more painful consequences further down the line. Another troubling development in the shadow banking industry is that the relatively high borrowing costs means many companies are increasingly dependent on short-term profits and, in turn, higher growth rates being sustained – again fuelling the economy’s reliance on capital spending.”