China: Carrot-and-Stick - Coface

COFACE COUNTRY RISK CONFERENCE 2014 / 12 NOVEMBER 2014 1

China: Carrot-and-Stick

Rocky TUNG,Economist, Asia-Pacific Region, Coface

In the Search of Growth Momentum

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Content

Macroeconomic environment

Sectoral development

Property

Steel

Conclusion

2COFACE COUNTRY RISK CONFERENCE 2014 / 12 NOVEMBER 2014

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2011 2012 2013 2014F 2015F

GDP growth (%) 9.3 7.8 7.7 7.4 7.0

CPI (%) 5.4 2.7 2.6 2.3 2.9

M2 (%) 13.6 13.8 13.6 13.0 13.0

Fixed Asset Investment (%)

23.8 20.6 19.6 16.3 16.0

Retail Sales (%) 17.1 14.3 13.1 12.2 11.2

RMB/USD (year-end)

6.301 6.286 6.097 6.100 5.978

Source: CEIC, Coface estimates

Continuation of the slowing trends


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Policy stance and expected steps going forward


Growth stabilization

Managing expectation

Strengthening economic structure

Targeted stimuli

Lower growth target

Continuation of structural reform

Job creation Inflation Growth

Source: Coface

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Monetary expansion is less effective in managing structural slowdown

COFACE COUNTRY RISK CONFERENCE 2014 / 12 NOVEMBER 2014 5

Source: CEIC, Coface estimates

Money supply growth is becoming less-efficient in boosting growth

A steady structural shift toward the 7% range

Nominal GD M0 M1 M21Yr lead 0.1109 0.3961 0.5847 0.34063Q-lead 0.3552 0.4965 0.6556 0.23012Q-lead 0.6068 0.5783 0.6074 0.08441Q-lead 0.8353 0.4529 0.4233 -0.1410Simultaneous 1.0000 0.4811 0.1991 -0.2671

Nominal GDP/ Money Supply

6%7%8%9%

10%11%12%13%14%15%

Slowing GDP growth in China

GDP Growth

YoY

13.4%

10.2%

7.8%

Avg for 2014/15 7.2%

0%

50%

100%

150%

200%

250%

Nominal GDP growth / M1 growth (9M‐lead)

M1 Correlation (10‐year) @ 0.6610‐year average @ 105%

Now @ 95%

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Month MeasureApril (Apr 22) PBoC lowered RRR for rural commercial banks (200bps) and lenders with agricultural

purposes (50bps)

May (May 7) The Finance Ministry and State Administration of Taxation said that any company with annual taxable income below RMB100000 would have 50% tax cut (i.e. 20%) from 2014 till 2016;two million firms to benefit. Firms with under 100 employees, with revenue limits, will also benefit

June (June 9) PBoC introduced selective- RRR cut for financial institutions that end to agricultural sector and small & micro firms, as well as finance, financial leasing and auto finance companies(June 13) China to cut VAT (i.e. from 4-6% to 3%) on small firms (June 30) Regulators increased banks’ lending capacity by altering the way loan-to-deposit ratio (i.e. ceiling at 75%) are measured

July (July 24/25) CBRC said it would continue to extend support to small companies through reducing “inverted” lending activities; 3 privately-owned banks were approved to be set up (i.e. WeBank in Shenzhen, and 2 others in Wenzhou and Tianjin)

September (Sept 16/19) PBoC has extended RMB500b worth of Standing Lending Facility (SLF) to top 5 banks(Sept 29) Two additional privately-owned banks were approved to be established in Shanghai and Zhejiang

October (Oct 8) State Council wrote in a document regarding budget reform, which includes aspects of increasing transparency of budget and quota on local government debt issuance(Oct 17) PBoC is said to extend SLF program to 11 banks by about RMB200b

Targeted-stimuli in place (non-exhaustive)

COFACE COUNTRY RISK CONFERENCE 2014 / 12 NOVEMBER 2014

Source: State Council, MoF, CBRC, PBoC, CNBC, Bloomberg, Reuters, WSJ, NY times, Sina, Tencent, China Daily, Coface

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Content



Property

Steel

Conclusion


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Sectoral Risk Assessment (non-exhaustive)


Source: Datastream data, Coface (September 2014)

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Property

A key part of the Chinese government’s urbanization plan

An important source of government revenue

A huge downstream market for other sectors like steel and cement, and thus iron ore, coal and other commodities


Source: Coface

Why do we talk about it?

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Lack of alternate source of financing hurts business climate of property sector…

Source: CEIC, Coface


Deteriorated environment for the property market in 2014

*Source of fund, area of land development, area of building construction, sale price, floor space for sale, etc

Property developers faced difficulty in obtaining financing-facilities from “other sources”

10

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

0%

10%

20%

30%

40%

50%

Other sources (RHS) Self‐raised (RHS)Foreign investment (RHS) Domestic loan (RHS)Real estate investment source of fund

YoY RMB m

‐9.1%

+11.5%

+11.8%

‐15%

‐10%

‐5%

0%

5%

10%

15%

889092949698

100102104106108

Real estate climate index RECI YoY changeindexed: Year 2000 = 100

GDP slowed for 6 consecutive

quarters; withdrawal syndrome; curbing

property sales

GFCWorries of

overdevelopment; lack of “other”

financing sources

/

…which is reflected in prices and transaction volume…


Pressure on real estate transaction volume and investment


Prices are falling in a record number of cities

11

-20%

0%

20%

40%

60%

80%

100%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 9M2014

Building Sold (RMB m) Residential Building Sold (RMB m)

Real estate investment (YTD)

YoY

0

10

20

30

40

50

60

70

Decreased (MoM) No Change (MoM) Increased (MoM)

No. of cities Newly Constructed Residential Building

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…but the property market is too important to see no support…

And land sales represent a key role in government financing

Property market takes a key position in banks’ portfolio



18.9%

19.4%

19.9%

20.4%

20.9%

21.4%

0%

20%

40%

60%

80%

100%

3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14

Individual Housing Mortgage/Real Estate LoanReal Estate Development Loan/Real Estate LoanReal Estate Loan/Total RMB Loan (RHS)

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

0%

5%

10%

15%

20%

25%

30%

35%

2009 2010 2011 2012 2013Government revenue (RHS)Debt issuance / Govt revenueIncome from land usage right transfer/ Govt revenue

RMB m

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Steel

A barometer for the other sectors in China (property, construction, shipping, automobile, electronics, etc.)

A traditionally important industry that is facing tremendous pressure – provides indication of government policy direction

Arguably a price-setter for the regional market


Source: Coface

Why do we talk about it?

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Major sources of steel demand see weakened growth and the trend is set to continue


Approximated end-demand of crude steel in China

Source: Coface estimates

Property, 28%

Infrastructure, 26%

Machineries & appliances, 23%

Automobiles &

shipbuilding, 9%

Power & coal, 3%

Others, 11%

Property

Infrastructure

Machineries & appliances

Automobiles & shipbuilding

Power & coal

Others

2013 steel demand (estimates)

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Subpar utilization of steel production facilities continues to hurt earning abilities


Steel mills’ financials have improved, albeit slightly

Utilization of production capacities remains south of 80% level

140%

150%

160%

170%

180%

190%

200%

210%

220%

230%

240%

-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

Total net profit/ total sales Debt/Equity ratio (RHS)

Source: CEIC, CUSTEEL, Coface estimates

60.0%

65.0%

70.0%

75.0%

80.0%

85.0%

90.0%

95.0%

2006 2007 2008 2009 2010 2011 2012 2013E 2014E

Utilization: Crude Steel Utilization: Steel Product

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Crude steel = Coke (from coking coal) + iron ore + scrap steel


Already depressed coal prices have limited downside unless we will see a collapse of the industry

High iron ore inventory is depressing prices


0

20,000

40,000

60,000

80,000

100,000

120,000

Iron ore inventory at Ports

'000 tons

3,5004,0004,5005,0005,5006,0006,5007,0007,5008,0008,500

360

410

460

510

560

610

660

710

01/13 03/13 05/13 07/13 09/13 11/13 01/14 03/14 05/14 07/14 09/14

Coal Inventory: Port: Qinhuangdao 5800 Calorie: Datong High-quality

5500 Calorie: Shanxi High-quality 5000 Calorie: Shanxi Common

4500 Calorie: Common

RMB/t k tons

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Content



Property

Steel

Conclusion


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Expectation of near-term development

Policy stance

• Reform to continue at a managed pace

• Continuation of targeted-stimulus approach as a stabilizer for growth

• Growth target to moderate in 2015

Liquidity

• More active open market operations to manage liquidity

• Stricter regulations on shadow-banking facilitators

• Further assistance extended to SMEs and micro firms

Property market

• Demand to stay at low level

• Price pressure remains as inventory awaits to be digested

• Less-strict policy stance expected to be used as a “stimulus” for the market, but effectiveness is unclear

Steel

• Accelerated dismantling of outdated production capacity

• Medium-sized steel mills to face liquidity pressure

• Profitability to remain at depressed level

• Low value-added traders to be out of business


Source: Coface

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Conclusion

Continued growth

stabilization

Effective policy

execution

Ongoing structural

reformSustainable development


Source: Coface

Average growth rate of 7.2% in 2014/15; continuation of targeted-stimuli approach

Effective investment and well-planned urbanization;

reduction in pollution

Dismantling outdated capacity; continuation of anti-corruption scheme; liquidity management

Become less-reliant on fiscal & monetary stimuli;

RMB internationalization

2014 Coface Country RiskConference

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China: Carrot-and-Stick - Coface