“Our (Growth-)Temperature Indicator Falls to 4.0 – the Second Lowest Ever ”

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LNU’s China Panel No 21 – February 23, 2016

“Our (Growth-)Temperature Indicator Falls to 4.0 – the Second Lowest Ever ”

Summary Between January 8 and February 4, we made our regular winter survey on growth conditions in China. The

structural part of our survey is addressed this time in the beginning of the year – and not, as usual, in spring.

Almost 20 China experts participated, coming from Europa, North America and Asia. Best thanks to all of them!

¤ Our so-called temperature indicator for the Chinese economy fell visibly to 4.0 from 4.3 last spring. This is only 0.1 percentage point above our all-time low in spring 2009.

¤ There is a slight downward revision for GDP growth in 2016 (to 6.3 from 6.5 % last May, based on official statistics for 2015) – with some downward bias. 6.3 percent is probably quite close to the lower limit of what officials currently can accept. But the quality of GDP growth is considered by China’s top politicians as more important than the pure numbers. The main contribution to GDP growth in 2016 is expected to come from consumption.

¤ The panel also identified the three biggest short-term problems:

1) financial markets (generally), 2) debt problems, 3) weaker currency (RMB).

¤ Some structural issues (scale 1 - 10, 10 = very good) on a) quality of economic statistics: 3.7 b) quality of corporate accounting: 3.5

c) transparency of financial markets: 3.5 d) marketization of the banking system: 3.8 e) marketization of the stock market: 3.7 f) marketization of the bond market: 4.5

Hubert Fromlet

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1. LNU’s “Temperature Indicator” confirms growth concerns - very close to our all-time low

Index result in January/February 2016 (average): 4.0 (May 2015: 4.3; December 2013: 6.2) Our “Temperature Indicator” for China’s economy is now more than eleven years old. Only in spring 2009 – during the worst days in the aftermath of the “subprime” crisis – we noted an index number that was slightly lower (3.9) than the current one (4.0). This can be compared to the highest number ever in our survey history – 7.9 in fall 2007.

The downward trend is obvious. However, the weakening of GDP growth should not be interpreted as very worrisome per se (if we assume for a moment that the published GDP numbers are correct).

Political leaders could certainly accept the downsizing of Chinese GDP growth – if such a development at the same time is in line with promising improvements of the quality of economic growth. Many plans in such a direction exist since the Communist Party’s Third Plenum in November 2013. But there is still not enough information about the commenced structural efforts and their results so far. And what about a possible weakening of Chinese (product) competitiveness or pure business cycle reasons for the slowdown? Imports from China are still developing quite modest in many OECD countries. Unfortunately, Chinese communication is still underperforming. This is bad for both Chinese and non-Chinese analysts.

2a. Predictions for GDP growth are slightly lower than official ones

(in percent, average)

2015: 6.9 (official) (May 2015: 6.8) 2016: 6.3 (panel) (May 2016: 6.5)

2016 q4: 6.2 (panel) (May 2016: 6.5)

Own comment:

Our panelists have proved to be good forecasters during the years, and for 2015 again. For 2016, they see a slightly slower GDP-growth rate than Chinese officials do who mainly are talking about 6.5 percent. The panelists have, of course, to use official numbers as reference points – and not the GDP changes as they may develop in reality. Anyway, some further slight downturn is expected for 2016. Is this possibly already below the “new normal”?

2b. Again – three out of four China panelists assume only a gradual and modest global recovery

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3. Consumption - China’s main growth contributor in 2016

The results of this question are unambiguous: (private) consumption turns out to be the main

contributor to China’s economic growth in 2016 (75 percent), followed by investment (17 percent) and possibly – to a very limited extent - net exports (8 percent). That’s exactly the way Chinese top

politicians want to see the new growth model – but it needs also stability in its development.

4. Downward bias for own GDP forecast still dominating

63 percent of our China Panel works with the assumption that their GDP forecasts may have a so-called downward bias, i.e. that a different outcome from the own growth forecast rather will be on the negative than on the positive side. In other words: growth optimism is not back (yet?).

5. The three major short-term concerns about the Chinese economy – i.e. during the next 4-6 quarters – are led by…

(ranked)

¤ financial system, financial markets (generally)

¤ debt problems

¤ weaker currency (trade war)

Own conclusion:

Our experts are mostly concerned about financial markets and their imbalances. These kinds of answers dominate clearly. Many financial factors are mentioned, such as the stock market, the debt problem, shadow banks, distortion on the real estate market, further weakening of the yuan, credit losses of the banks (overcapacity in industry), etc. The whole process of regaining global markets’

confidence will be difficult for China’s political leadership without applying better transparency and communication.

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6. The major three long-term concerns about the Chinese economy – i.e. more than 2-3 years from now – are led by…

(ranked)

¤ financial system, financial markets

¤ demography

¤ debt problems

Own conclusion:

Financial risks dominate the concerns of our China Survey Panel also in the longer run. Debt implosion has become a new key word. The demography problem cannot be solved within the near future – despite the recent implementation of two-child policy. Many other issues give reason for concern, too, such as the politicians’real reform ambitions more generally, the environment, political and social challenges, unemployment problems, etc.

7. Do you expect the renminbi during 2016

¤ to depreciate slightly (1-5 %): 69 %

¤ to depreciate more visibly ( >5%): 23 %

¤ to be stable: 8 %

¤ to appreciate -

Own comment:

Chinese decision makers have declared more recently that the renminbi (RMB) should not become a chronically weak currency (but can fluctuate in line with market forces). This view is reflected by the answers given above. Somewhat surprising, however, is the observation that no panelist regards the RMB as an appreciating currency anymore, at least not in the course of this year.

8. Do you think there is still a dangerous price bubble on the …

¤ stock market yes: 54 % no: 46 %

¤ real estate market yes: 67 % no: 33 % Own comment:

A clear majority of the panel still sees considerably larger bubble risks for the real estate market than for the stock market. This may be interpreted as somewhat surprising. In our next survey, we will also

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9. Your general confidence in the Chinese economy (5 = very high)

¤ 3 years from now: 2.7 (November 2014: 3.3)

Own comment:

The results of this question are quite interesting since confidence in the Chinese economy seems to be slightly improving over time. Before, it was regularly the other way around. This new order indicates that the panelists feel increasingly concerned about the short-term

problems – but not really dramatically either. The real long-term view, on the other hand, has become somewhat more positive in the (average) eyes of the panelists.

10 a. Trust in Chinese economic statistics – still a long way to go (10 = very much; 1 = not at all)

February 2016: 3.7 (April 2014: 4.9) (Fall 2010: 4.4)

Own comment:

The somewhat negative trend when watching the numbers in the past two years can probably be explained mainly by the fact that the China’s statistical quality problems have caused international attention only more lately.

10 b. Have you seen any improvements in the past 2-3 years?

Yes: 63 % No: 37 %

Our comment:

The answer to this question seems to be somewhat contradictory to what has been said in 10a.

However, the question of 10b covers a longer period (2-3 years) than the 21 months in 10a from April 2014 to February 2016. But it may also be the case that lagging transparency may lead to some inconsistency in this part of our survey.

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11 a. Trust in Chinese corporate accounting – remaining insufficient

(10 = very much; 1 = very poor)

Our comment:

We probably are in this context confronted with the same phenomenon as in the previous question.

Growing awareness of China'sunderperforming corporate accounting is probably most responsible for the downturn of trustworthiness of corporate accounting since 2010 – despite some possible progress in the past 2-3 years as indicated in 11b. However, the current average grading of 3.5 is still by far too low. This means that it remains hard to have a well-founded opinion on the valuations of the two stock exchanges in mainland China.

11 b. Have you seen any improvements in the past 2-3 years?

Yes: 45 % No: 55 %

12. Transparency of financial markets - one of the major problems (10 = very much; 1 =very poor)

February 2012: 3.5 (April 2014: 3.3) (Fall 2010: 3.6) Own comment:

Improvements of transparency in almost all political, social, economic and financial areas still belong to the most important challenges for Chinese leaders. The grading by our panel remains roughly unchanged compared to 2010. This is certainly not satisfactory for the second largest economy in the world and for a giant country that wants to develop its domestic financial markets ambitiously (and not to forget the planned and difficult deregulation of financial cross-border capital movements which really requires more transparency).

13. China’s total institutional framework – more progress needed (10 = very good; 1 = very poor)

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promising institutional plans can be accomplished in reality. More communication from China – also about positive developments– would be very useful

14. Marketization of the financial system - more efforts urgently needed (10 = very good; 1 = very poor)

- the banking system February 2016: 3.8 (April 2014: 3.5) (Fall 2011: 3.8) - the stock market February 2016: 3.7 (April 2014: 4.2) (Fall 2011: 4.5) - the bond market February 2016: 4.5 (April 2014: 2.9) (Fall 2011: 4.2)

Own comment:

A well-working marketization of the financial system is one of the most important

objectives/decisions of the Central Committee’s Third Plenum. The numbers above, however, indicate that there still is a lot of work to do. A modernized domestic banking system would serve as one of the most important pillars of a developed (emerging) country. Well-working stock markets are always needed for the supply and availability of risk capital, in China as well. And a well-equipped and organized bond market must be regarded as an extremely important precondition for a modern monetary policy (which China still is missing). Altogether, more modernizing efforts are urgently needed for China’s financial markets.

15. China’s sensitivity to rising interest rates in the U.S. - not negligible but not alarming either

(10 = very sensitive)

February 2016: 4.6

Own comment:

There is no doubt according to the panel: rising American interest rates have an impact on China, particularly via the exchange rate (which the panel was not directly asked about). The impact should not be described as considerable as long as hikes of U.S. rates remain quite limited – but it is not negligible either.

16. China’s GDP growth 5 ¼ percent on average 2016 – 2020 - not too bad if it really becomes true

February 2016: 5 ¼ % (Fall 2014: 5 ¾ %)

Own comment:

It would be quite satisfactory if China could achieve a GDP-growth rate around 5 ¼ percent on

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average in the forthcoming five years (predicted 5 ¼ percent related to officially published 6.9 percent growth in 2015), particularly if many structural reforms have been put in place. But it should not be less than 5 percent. Otherwise it would become very hard to finance all the costly objectives that have been set by the Third Plenum such as remarkable improvements of social security, education, health and the environment.

17. Do you expect during the forthcoming five years

- a gradual, still quite cautious acceleration of economic policy reforms 69 % - a very slow pace of economic policy reforms 31 %

Own comment:

LNU’s China Panel does not show major optimism about the expected speed of future economic policy reforms. This result is no surprise – particularly not when considering that the plans and decisions of the Third Plenum contain a lot conflicts of goals. Many intended reforms need bottom-up approaches which usually take quite some time to get successfully through the system or the organization to be reformed.

18. Which three reform areas will be the most visibly preferred by China’s political leadership?

(Ranked)

- Environment

- Financial markets - Hukou (urban registration of – mostly – rural workers/population)

Own comment:

The three above-mentioned reform areas are, of course, extremely important – but others as well. The panelists also mention the fight against corruption, social security, urbanization, market prices, etc.

One of the biggest challenges still is to receive persistent information about the progress of different reforms.

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Conclusions

¤ There is no doubt that our panelists have become more concerned about the future of the Chinese economy. GDP growth is expected to decline further – but without coming down to really worrisome low growth, at least as long as – in my view - the quality of GDP growth can be improved at the same time. Improved growth quality is a concrete political objective.

¤ The concerns of our China experts are mainly related to financial markets – a sector in the economy that is, unfortunately, characterized by many shortcomings in transparency. We know simply too little about the real state of the Chinese financial system. The other institutional issues in our survey are still underperforming, too. Economic statistics and corporate accounting, for example, receive again quite low gradings – without visible or significant progress in the past few years.

¤ An explanation for the disappointing institutional trends in our survey may be that these factors only more recently have become significant topics in literature and in the press. This new attention may – hopefully – speed up China’s necessary process of institutional reform ambitions in its role as an increasingly influential global player.

¤ In October 2017, the 19^thNational Congress of the Communist Party will replace five out of seven seats in the Politburo’s Standing Committee, the most important institution for political decisions in the Middle Kingdom. Only President Xi Jinping and Prime Minister Li Keqiang will keep their seats.

Who will be the new decision makers and which factions will they represent?

¤ Furthermore, the above-mentioned National Congress in 2017 will give more answers to China’s new economic policy (as implemented by the Third Plenum in November 2013). The plans for the new economic policy look promising on the paper – but how much of these decisions will become reality? There are many possible impediments, particularly all the conflicts of goals that exist in the

reform decision paper itself.

¤ Not to forget: the financial risks that have been emphasized strongly as more critical than before by the respondents in our new, the 21^st China Survey Panel.

Hubert Fromlet