Bonds Policy will Ease Debt Risk
Executive Summary
Fixed asset investment growth continues to decline, rising 17% in real terms in May, while industrial output growth dipped 1 p.p. y/y from 2013, to 8.8%. Yet the general trend is relatively stable this year. The low new project investment growth rate of 12.5% sheds light on the weakness of future investment. The government has responded promptly, by increasing state lending. We expect overall economic growth to be stable – or to, at worst, mildly decline.
Retail sales of consumer goods rose 10.7% y/y in real terms, down 0.2 pps from April. CPI rose 2.6% y/y, up 0.7 pps. We expect this increase to be temporary, due to the temporary food price shock; we forecast June CPI to be 2.2%. The ex-factory price index of industrial products fell -1.4% y/y, and PPI fell -1.8% y/y. So mild deflation is still a threat.
Exports rose 7% y/y, up 6.1 pps from April. On May 15th, the State Council released its No. 19 document: “The State Council’s Several Opinions on Supporting Steady Growth in Foreign Trade,” which includes 16 supporting policies, allocating each ministry detailed responsibilities. We believe these new policies, atop last year’s low base trade number and a U.S. economic recovery, will bolster export growth this year.
Prime Minister Keqiang Li last month made comments suggesting that monetary policy would be relaxed. During a visit to Inner Mongolia on May 23rd, Li said that monetary policy must keep loan growth at a reasonable pace. At the end of May, M2 was up 13.4% y/y, M1 up 5.7% y/y, and M0 up 6.7% y/y, rises of 0.2 p.p., 0.2 p.p., and 1.3 p.p. from April.
We expect the State Council’s May 19th decision to allow 10 provinces and cities to issue municipal bonds on a trial basis to alleviate fiscal pressures on local government, and to lower debt risk. This decision was taken to address the dramatic rise in local government debt, to $3 trillion in 2014, from $50 billion in 2004. In the Chinese setting, the moral hazard problem is unlikely to be as bad as some have argued. Local government relies heavily upon selling land to raise funds, a phenomenon vociferously criticized as contributing to the housing price boom. But decreased fiscal pressure will mitigate this dynamic. We also think more bond issuance will ease inflationary pressure, and offer the Central Bank greater flexibility to pursue a more relaxed monetary policy.
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