China’s evolving Economic dynamics and Investment implications

China’s evolving Economic dynamics and Investment implications

By Vaibhav DhabariaApril 1, 2016

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China’s economic growth is faltering ...

• China’s Real GDP growth rate fell to a 25-year low at 6.9% for the year 2015 vs. 7.3% in 2014. Target GDP growth rate for 2016 has been set at 6.5% to 7.0%.

• The slowdown in nominal terms was steeper from 6.4% in 2015 vs. 8.1% in 2014, which will make debt servicing harder.

• Questions have been raised about authenticity of these numbers as estimates range from 3% to 7%.

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

USD

(bn)

Change in Nominal GDP Real GDP

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Source: Bloomberg, CEIC, Author’s calculation; Data as of : 3/15/2016

.. as the government attempts to “rebalance” the economy

• A lot of the slowdown is a result of the gradual shift in the structure of the economy from an investment-led economy to a more consumption and service driven economy.


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Weighting of each sector

Agriculture Manufacturing Services

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Real Growth of each sector

Agriculture Manufacturing Services

51%

41%

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Major Concerns and Events:

I. New Exchange rate regime introduced for RMB in 2015 …

A. August 11 - PBoC introduces a more “market based” regime to fix USDCNY exchange rate. (based on the previous day’s closing rate.)

B. November 30 - RMB included in IMF’s Special Drawing Right (SDR) basket.

C. December 30 - PBoC introduces new trade-weighted exchange rate basket which measures the strength of RMB against a broader basket of 13 currencies (with USD, EUR and JPY accounting for 2/3 of the basket.)

D. January 6 – Stock market trading halted as CSI 300 Index plunge by 7%..

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Jan‐15 Feb‐15 Mar‐15 Apr‐15 May‐15 Jun‐15 Jul‐15 Aug‐15 Sep‐15 Oct‐15 Nov‐15 Dec‐15 Jan‐16 Feb‐16 Mar‐16

Events CNY CNH

Appreciation

A C

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Source: Bloomberg, Author’s calculation; Data as of : 3/15/2016

Depreciation

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... which sparked panic in the currency markets

• The PBoC plans to impose a Tobin tax on foreign exchange transactions to curb the speculation in the currency markets.

• This might come as a surprise to some, as the yuan seems to be becoming stable and the spread between the onshore and offshore yuan is close to zero.

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bps

CNH‐CNY Spread


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II. Foreign Reserves have been falling …

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Jan‐13 Apr‐13 Jul‐13 Oct‐13 Jan‐14 Apr‐14 Jul‐14 Oct‐14 Jan‐15 Apr‐15 Jul‐15 Oct‐15 Jan‐16

USD

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Change in m/m levels of FX reserves FX reserves

Source: Datastream, Author’s calculation; Data as of : 3/15/2016

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... as the authorities try to manage the currency slide

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USD

/CNY

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FX Reserves USD/CNY spot

Source: Bloomberg, Datastream, Author’s calculation; Data as of : 3/15/2016

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III. Accommodative Monetary policy employed

• The PBoC cut bank the reserve ratio requirements (RRR) on February 29 in its effort to boost growth, releasing an estimated $100 billion of capital for lending.

• Other measures like repo market operations and Standing Lending Financing are being used to increase liquidity in the economy.


3.00%

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One year benchmark interest rate

Six rate cuts since November 2014

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Further, officials set a target of 13% for M2 money supply growth in 2016 (vs. 12% in 2015)


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M2 money supply growth (y/y)

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IV. Credit growth is expected rise in 2016

• Total social financing (TSF), an important indicator of China's credit expansion, reached a record of 3.42 trillion yuan in January, though, it fell sharply to 780.2 billion yuan in February. However, it is expected to rise during the year as efforts to raise credit growth to give growth a push increase.

Source: Datastream, CEIC, Author’s calculation; Data as of : 3/15/2016

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New Loans in RMB Total Social Financing

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V. China’s Debt level remains a major concern …

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

% of G

DP

Household Debt Corporate Debt Government Debt Bank Debt Total Debt


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... and Non-Performing loans continue to rise!

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Change in m/m level Non‐Performing loans

• Even thought the data suggests that Non-performing loans ratio of China’s commercial banks is 1.67% for 2015, the nominal amount is huge at 1.2 trillion yuan.


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VI. Financial markets have reacted negatively to this …

• China's Shanghai Composite Index, the main equity market benchmark, has been on a rollercoaster ride recently. After reaching 5000 level first time since 2008 in June last year and registering a growth of 55%, this year it recorded one of its worst starts to a year, slipping by more than 15% in a fortnight.

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6000 YTD return Shanghai Stock Exchange

Worst beginning to a year

Source: Bloomberg, Author’s calculation; Data as of : 3/15/2016Past performance is no guarantee of future performance.

Reached 5000 level first time since 2008. YTD returns : >50% for a week

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... and the cost of insuring Chinese Sovereign Debt has risen to one of highest levels.

• The cost of insuring Chinese sovereign debt against default climbed to the highest level since a record cash crunch in June 2013 trading at above 140 bps. Also, Chinese 5 year CDS presently trades more than Philippines (which is 4 levels above Sovereign Ratings of S&P), highlighting how risky the market thinks China is.


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5Y CDS‐ China 5Y CDS‐ Philippines

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Outlook

Major Risks

Domestic Risks: • The rate at which PBoC depreciates the Renminbi - as a significantly rapid rate of

depreciation can lead to further capital outflows. • Further deterioration in the Real Estate market.

External Risks:• Growth shock to US, Eurozone or Japan.• Significant volatility in Energy prices.

Upside Risks: • Pickup in growth rates China’s major trading partners (US, Eurozone and Japan). • Pickup in the huge internal consumer market.

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Major Strengths:

• Low external vulnerability • Under control Fiscal deficit• Capital Account surplus • Huge, though depleting, FX reserves

Outlook:Apart from the PBoC measures, the government is taking fiscal measures like taking up infrastructure projects and introducing tax cuts to revive the economic growth. Also, resolving overcapacity in the system remains a priority. It is expected that the adjustment from an investment-led to a more consumption-driven economy will take time, however, chances of a Hard Landing seems overblown in the short term.

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Investment Implications:

Developed Markets: Volatile times ahead !

• As China attempts to rebalance its economy and tries out new policies, we can expect volatility in the Developed Markets Stock exchanges.

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450Economic Policy Uncertainty Index Volatility (30 days) of MSCI World Index

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Emerging Markets Currencies: Devaluation ahead ??

• A devaluing Yuan might just mean devaluation by other Emerging markets currencies as well.

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** EM Basket consists of 10 randomly chosen countries (except China) from MSCI EM index. The countries selected are : India, South Africa, Hungary, Indonesia, Malaysia, Poland, Russia, Mexico, Peru and Thailand.

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Feb‐13 May‐13 Aug‐13 Nov‐13 Feb‐14 May‐14 Aug‐14 Nov‐14 Feb‐15 May‐15 Aug‐15 Nov‐15 Feb‐16

Change in USD/CNY spot (m/m) Change in EM basket currencies (m/m) **


Emerging Markets: Commodity Exporters

• As China’s global share suggests, it is one of the biggest consumer of commodities. As China rebalances its economy towards a more Service sector based economy, the demand for these commodities is likely to fall, thereby depressing its prices. Many commodity exporting Emerging economies (like Brazil, Chile and Australia) might face a tough time as a result.

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60%China's Share in Global demand

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Source: World Economic Forum, Author’s calculation; Data as of : 3/15/2016

About the Author:

Vaibhav Dhabaria is an experienced Macro Analyst with 2 years of Investment Research experience. Currently, he is doing his MS in Financial Statistics and Risk Management at Rutgers University. During his previous work experiences, he has worked closely with Senior Portfolio managers and Senior Economists on projects ranging from

Macroeconomic research on various economies to building quantitative tools to assess the health of the economy. With his education in Economics, Statistics and programming he plans to start his career in the Financial industry soon after his graduation in May,2016. Prior work experiences: Investment Analyst I at Bank of New York Mellon (2012 to 2014).Emerging Markets Summer Intern at The Hartford (2015)

Please feel free to send your feedback or queries about the presentation.

Email ID: [email protected]: https://www.linkedin.com/in/vaibhav-dhabaria-2b588b47

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Thank you !

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China’s evolving Economic dynamics and Investment implications