Summary

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  • The 19th CPC National Congress resulted in a consolidation of power and elevation of the status of Party General Secretary and President Xi Jinping
  • This allows Xi to focus on his three-decade vision and two-stage development plan of turning China into a leading global power by 2049. This could also potentially mean quicker decision making and more effective implementation of Xi’s agenda
  • There is a shift in emphasis away from short-term growth objectives towards long-term quality and sustainability of economic development, though we think maintaining steady growth remains a priority
  • Xi called for supply side reforms to deepen and innovation-driven development to accelerate. SOE, fiscal and financial (including FX) reforms continue to rank high on the reform agenda. We expect deleveraging to continue and financial regulations to be strengthened and more coordinated
  • Focus has also been on long-term property policy management, rural land reform, the build-up of city clusters, and opening-up. There is great emphasis on environmental protection, income distribution, social protection, and provision of public services
  • With stability remaining a priority, renewed focus on de-risking policies and structural reforms to ensure higher-quality and more sustainable growth should be positive for the Chinese economy and asset markets in the medium-to-long term


This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination.

The party leadership reshuffle

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The 19th National Congress of the Communist Party of China (CPC), concluded on 24 October, resulted in a consolidation of power and elevation of the status of Party General Secretary and President Xi Jinping. The Politburo Standing Committee (PSC), China’s top decision-making body, was unveiled at its first plenary session on 25 October. The composition of the PSC shows that the informal rule on retirement age is upheld, but the new PSC does not include any clear candidates to eventually succeed President Xi (or Premier Li Keqiang) when the current 5-year term ends in 2022 — a departure from the conventional practice that had been in place since the 1990s. Meanwhile, the "Xi Jinping Thought on Socialism with Chinese Characteristics in the New Era" was added to the Party's constitution.

It seems likely that Mr. Xi’s influence over the party and policy direction could extend beyond 2022, allowing him to focus on his three-decade vision of turning China into a leading global power. This concentration of power could potentially mean quicker decision-making and a more effective implementation of Xi’s agenda, although there could be investor concern about whether the system has any checks and balances.

The Party Congress did not signal any material changes to the current economic policy setting or to the broad direction of structural reforms. We do not expect a shift to a bold or big-bang reform approach, and expect the authorities to continue their gradualist and calibrated approach towards reforms, with more targeted reforms in selected sectors. This will likely be complemented with a broadly supportive macro policy setting to ensure that restructuring or reforms do not significantly threaten short-term growth, financial and social stability.

Two-stage long-term development plan

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Mr. Xi reiterated the goal of building a “moderately prosperous society” by 2020. The quantitative goal of “doubling GDP and income per capita by 2020 from the 2010 levels” implies minimum annual GDP growth of ~6.3 per cent in 2018-20. This suggests maintaining steady growth will likely remain a priority, although it leaves room for the government to soften the growth target for the next three years at the margin from “about 6.5 per cent” for 2017, in our view. We believe broad economic stability is important to create a benign macro environment for economic restructuring and structural reforms.

He also laid out an ambitious two-stage long-term development roadmap (2020-2049): China’s economic and technology power should progress significantly, to become a top-ranked innovative country by 2035, with significant expansion of the middle income class, narrower income inequality and urban-rural disparity, a broad-based provision of basic public services, a society governed by the rule of law, and a notable improvement in environmental standards. China will become a “great modernised socialist country” with leading global influence by 2049. We expect policy to be less constrained by growth targets after 2020.

Emphasis on quality of growth

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Mr. Xi redefined the ‘principal contradiction’ facing the society in the new era as the gap between ‘unbalanced and inadequate’ development and people’s ever-growing demand for a better life. This challenge is reflected in areas such as low quality and efficiency of development, shortcomings in innovation capabilities, environmental protection and income inequality, and inadequacies in employment, education, healthcare, housing, elderly care, and other social development. The Chinese economy is progressing from a high-growth phase to a high-quality development stage.

Focus on de-risking and structural reform

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Supply-side, state-owned enterprise (SOE), fiscal and financial reforms will likely continue to rank high on the reform agenda, although the full version will be finalised only at the third plenary session in the fall of 2018. While reiterating the need to reduce overcapacity, leverage and property inventory as well as improve infrastructure and provision of public services, Xi also called for a need to develop high-end manufacturing, better utilise developments of internet technology, big data, and artificial intelligence to support the real economy. He highlighted mid-to-high-end consumption, innovation, green energy, environmental protection, modern supply chain development, a shared economy, and human resource services as the new growth drivers.

A modern fiscal system should be established, with clear, well-balanced central and local fiscal alignments. Regulation on local government off-balance-sheet borrowing has been tightened. Financial reforms are likely to balance innovation with stability. Financial deleveraging will likely continue and regulation will be strengthened to prevent systemic risk. The “dual-pillar” macro management framework of ‘monetary policy’ and ‘macro prudential measures’ will be improved to safeguard the economy and financial stability. The latter includes a Macro Prudential Assessment (MPA) of banks, capital flow management, and property market measures, etc. The banking regulator will guard against cross-market financial risks and focus on interbank, wealth management products (WMPs) and off-balance sheet businesses in its crackdown on regulatory arbitrage and malpractices in the banking system. Financial regulation will be more coordinated under the newly-established Financial Stability and Development Commission, with the PBoC taking a leading role. Xi highlighted the importance of developing the capital markets and promoting direct financing. China will deepen interest-rate and exchange-rate reform and improve foreign access to its financial markets.

We think the authorities will move towards a more flexible exchange-rate regime amid ongoing FX reform. PBoC Governor Zhou Xiaochuan indicated during the Party Congress that widening the daily trading band is not the current priority, as the current band of +/-2 per cent around the fixing has not constrained RMB movements. SAFE pointed out that the PBoC had exited routine intervention and that FX flows are basically balanced, although this statement does not rule out ‘non-routine’ intervention. However, we do not expect a rapid pace of FX reform or an aggressive opening-up of the capital account. Meanwhile, Governor Zhou is set to retire, and we think the new governor is likely to ensure policy continuation. The Party’s top leadership will set the overall tone of monetary policy and financial reform.

Curbing speculation will remain the primary target of property policy. Xi reiterated that “property is for living, not for speculation” and called for an acceleration of the establishment of a housing system that focuses on both the purchasing and rental markets. Public/affordable and rental housing will become more important and receive more policy support. In large cities, rental home supply will increase significantly to meet the demand of low-income families, migrant workers and young graduates. Urbanisation and the build-up of city clusters, coupled with a bigger middle class, would lead to higher upgrading demand over the medium term.

While reiterating that the market will play a decisive role in resource allocation and China will improve market access for private investment (with the introduction of a “negative list” approach) and eliminate practices that impede fair competition, Xi also emphasised the leading role of the party and state in the economy. SOE reform is intended to make state capital stronger, better and bigger, and foster globally competitive, world-class Chinese corporates (the ‘national champions’). This could include facilitating the exit of loss-making zombie SOEs to channel state capital into more efficient enterprises. SOE reform will likely continue to focus on de-leveraging, mixed ownership to encourage private participation, restructuring and consolidation within sectors to achieve efficiency gains, and improving corporate governance, among others.

China will accelerate innovation-driven development, revitalise the rural sector, and coordinate regional development. China will push forward rural land reform, especially the “separation of three rights” i.e. (village collective) ownership, contractual and operation rights. The government will protect farmers’ long-term contractual rights to farmland and extend leasing contracts by another 30 years when they expire. The government has recently extended the rural land reform pilot, which started in 2015, to end-2018. The trial meant to develop mechanisms for rural land use rights to be transferred on markets, allowing rural residents to receive more of the benefits from their rights to land. China will also continue to promote urbanisation and city clusters, especially the Beijing-Tianjin-Hebei area and the Yangtze River economic zone as well as the big bay area linking Hong Kong, Macau and greater Pearl River Delta provinces, etc.

There is great emphasis on environmental protection, anti-pollution and green development, employment and household income growth, as well as income distribution and social security. A comprehensive, sustainable, multi-tier social safety system should be established, with provision of nationwide social security, pension and medical insurance coverage.

The Belt and Road initiative will be a key strategy of the opening up policy. China will grant more autonomy to free trade zones and explore the construction of ‘free trade ports’. Shanghai has embarked on the plan to build a free trade port, although details are pending. China will also significantly liberalise market access via the full implementation of a “negative list” system, open up service sectors to foreign investment, and protect foreign enterprises’ legal rights in China.

Investment implications

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As political dusts settle following the Party Congress, market focus may turn back on economic growth, corporate fundamentals, market-related policies, and the reform agenda. There could be some concern about a downshift in growth momentum and the removal of the “policy put” that has helped ensure a market-friendly environment heading into the key event. Concerns also remain over external risks (e.g. less accommodative Fed/DM monetary policy, US protectionist policies and geopolitical tensions, etc.). A benign global environment with a synchronised global recovery and supportive monetary policy/liquidity backdrop has allowed China to focus on its domestic policy agenda.

We expect economic growth to moderate into 2018, but we take a somewhat constructive view on the current modest growth slowdown, which partly reflects policy efforts to cut excess capacity, rein in leverage and shadow banking credit risks, reduce housing inventory and contain property-bubble risks, as well as enforce stricter environmental protection requirements and tighter rules for local government off-balance sheet financing. These efforts should help improve the quality and sustainability of long-term economic development. Meanwhile, consumption and the service sector continue to underpin growth, thanks to solid household income growth. Output and investment in higher-end manufacturing such as tech, discretionary consumption and pharmaceuticals has maintained robust growth.

With stability remaining a priority, the renewed focus on de-risking policies and structural reforms to ensure higher-quality and more sustainable growth should be positive for the Chinese asset markets in the medium-to-long term. In particular, a further opening up of the domestic equity and bond markets and (potential) global benchmark index inclusion are long-term catalysts, especially if they serve as a catalyst for further market reforms and more foreign and institutional investor participation.

Gains in Chinese equities this year, especially the nearly 50 per cent rally in MSCI China, have been backed by fundamental factors such as earnings growth, ROE recovery, corporate balance sheet adjustments, and a stable macro environment. SOE restructuring, industrial consolidation, overcapacity cut/supply-side discipline, and stricter environmental checks have helped a recovery in earnings, profitability and free cash-flow in the ‘old economy’ sector. De-risking in the financial sector via deleveraging and regulatory tightening to safeguard financial stability is a long-term positive for the markets and real economy. Valuations have risen but are not stretched and still look attractive vs. many other markets, based on our expected-return work.

We continue to see great opportunities in “new economy” sectors in the longer term, such as IT/ Internet/innovation, environmental protection and new/ green energy, and consumption upgrades and services (e.g. healthcare, leisure and travel, sports/ sportswear, media & entertainment, etc.). These will likely be key beneficiaries from Xi’s ambitious development agenda and economic transformation. Industrial upgrading, urbanisation, and a more open economy are also likely among key longer-term investment themes.

In the fixed-income market, the macro backdrop of moderately slower economic growth, benign inflation, improved capital-flow dynamics and reduced concern over RMB depreciation should be supportive. However, in the near term, we expect liquidity to remain stable but tight, and see limited room for monetary easing given still resilient growth, higher underlying inflation and ongoing deleveraging, barring any significant economic slowdown. Market volatility may increase amid further macro-prudential policy and regulatory tightening efforts. However, we expect prudent and broadly neutral monetary policy and limited risk of aggressive regulatory or liquidity crackdown.

The pace of onshore bond defaults has been well contained this year, despite tighter liquidity conditions and regulatory control of credit expansion, helped by improvements in corporate profits, cash flows and leverage. We think a sudden spike in default rates is unlikely, given maintaining growth and financial stability remain key policy goals, though idiosyncratic risks could stay elevated. Lower financial asset bubble risks may have reduced systemic risk concerns. Reforms to improve pricing of credit risks and credit differentials (e.g. the removal of implicit guarantees and SOE reform) will be positive for the long-term development of the Chinese bond/credit markets and efficiency in capital allocation in the economy.

Renee Chen
Global Investment Strategy Team

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