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Five themes for China in 2013
07 Dec 2012
Qu Hongbin, Co-head of Asian Economic Research
Things are starting to look up for China's economy. We identify five positive themes for 2013 but also see a potential external shock as the key macro risk.
A modest rebound in growth. More signs have emerged showing China's growth bottomed out in the final quarter of 2012 thanks to the earlier easing measures boosting domestic demand. While global demand will probably remain fragile, we believe the recovery can be sustained into 2013 and maintain our above-consensus forecast that China's 2013 GDP growth will recover to 8.6%, overshooting the likely 7.5% growth target to be unveiled at the upcoming Central Economic Work Conference.
Infrastructure investment will gain momentum as recent new projects get up to speed. Meanwhile, property investment is stabilising thanks to rising sales. All this, plus resilient consumer spending, should fuel a modest rebound next year and beyond.
Benign inflation. Unlike the V-shaped recovery in 2009, the rebound will be more modest this time. Despite the expected small rebound in the coming months, inflation should stay in check, not least because growth should remain below the potential growth rate. The inflation target is likely to stay at 2012's 4%. Price stability remains a priority, not only for economic development reasons but also for social stability.
Accommodative monetary and fiscal policy. The benign inflation outlook implies there is no need to tighten monetary and fiscal policy. Rather, it provides room for maintaining an accommodative policy stance to support a recovery in domestic demand.
For monetary policy, we expect the People's Bank of China to set an unchanged M2 money supply growth target of around 14% for 2013, with total social financing also similar to 2012. It will mainly rely on quantitative easing tools and open-market operations. But the chances of an interest rate cut have reduced, given that growth is bottoming. The lending rate has fallen notably following 2012's two rate cuts: we now expect the People's Bank to hold the one-year lending rate – its policy rate – at 6% into 2014.
For fiscal policy, Beijing is likely to keep the proactive fiscal policy in place to support growth. We expect fiscal expenditure to grow at above 16% a year to support infrastructure investment growth in the coming year. And the fiscal deficit is likely to reach around 1,000bn renminbi for 2013 compared with 2012's budget deficit of 800bn renminbi.
We expect fiscal policy to play a more important role in structural adjustment and income redistribution. Besides property and resources tax reforms, the key focuses will be spending – besides infrastructure, it is likely to be tilted towards social welfare and public housing – and VAT reforms that will help smaller and medium sized companies.
Reforms stepped up. Reform initiatives hold the key to maintaining economic development and sustaining rapid improvements in productivity that were key to the spectacular growth seen over the past three decades. We believe China's new leaders are well aware of the pressing issues.
Financial market reforms are gaining momentum. Bond issuance is accelerating and the market is likely to double in size in five years. It is time to increase the pace of bond market development to meet the huge demand for urbanisation. As this market expands, there will be a need further to liberalise interest rates. And we also expect the Peoples' Bank gradually to create a single interest rate benchmark in the next three years, leaving all other rates to be freely determined by the market.
The key macro risk in 2013 is a potential external shock. China is not immune to this.
Meanwhile, the pace of renminbi capital-account liberalisation is also speeding up, along with the increasing two-way and wider fluctuation of the currency's renminbi daily trading band and growing renminbi internationalisation.
Fiscal reforms hold the key for structural adjustment. Reform of the fiscal and tax system will be speeded up with the new leaders likely to focus on income distribution, industrial policy, environmental protection and social security.
Deregulation should revitalise the private sector. Five ministries and regulators – rail, health, state-owned assets, securities and banks – have already taken steps to boost private investment and reform state-owned enterprises. But the ultimate goal is to break the monopoly of these enterprises and allow fairer competition across a range of industries. Private enterprise is likely soon to gain access to sectors such as financial services, energy and telecommunication.
Meanwhile primary distribution reform is expected to help share the national cake more evenly between the government, corporate and households sectors and between individuals while secondary distribution reform will give priority to the lowest income groups, including farmers, and provide an adequate social safety net.
Renminbi internationalisation. This is gaining momentum, not only in terms of rising trade settlement volumes but also renminbi investment. The expansion applies to the domestic financial market as well as offshore renminbi centres but it is just the start of an emerging trend that will make extraordinary progress in the coming quarters.
However, the key macro risk in 2013 is a potential external shock. The US fiscal cliff and a potential deterioration of the European economy are likely to trigger a chain reaction in international financial markets and global economic growth. China is not immune to this, as shown by the sharp deceleration of export growth last summer.
However, should this happen, we believe China has sufficient policy ammunition to introduce additional easing measures to avoid a hard landing.