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China’s New Strategic Roadmap: Proactive Fiscal Policy, Prudent Monetary Policy
Malaysia Perspective | 20 May 2013

By Yeoh Mei Kei

It was hardly a surprise that the Chinese government maintained its growth target at 7.5% for 2013, after lowering it from 8% in 2012. We have witnessed the slowdown in the global economy weigh on China and subsequently seen trade, among other economic indicators bottom out in the third quarter of 2012. Despite the fact that we are further down the road in recovering, China’s economy over the long term is still expected to deliver slower growth compared to what we have seen in the past.

Slower long-term growth has been partially reflected through weaker foreign direct investment (FDI) gains. Last year, FDI dropped for the first time since 2009, declining 3.8% year-on-year. The decline was not detrimental, as we can see in Chart 1 that the absolute amount of investments was not far off from the record highs seen in 2011. Though part of this reflects weak sentiment from across the globe, we believe this is also reflective of a decelerating long-term trend. The FDI figure continued to contract at the start of 2013 and the government expects 2013’s FDI growth to be at a moderate pace of just 1.2%.

Chart 1: Foreign Direct Investments Growth

Looking at the other headline economic figures, while exports growth has rebounded substantially to gain 23.6% year-on-year in January and February, industrial production and retail sales have not revived as much as one would’ve hoped. The latter two figures gained a modest 9.9% and 12.3% year-on-year in the same period. A strong rebound in exports reflects improving global business sentiment, but we should note that going forward, as the domestic economy continues to transform, more modest growth rates can be expected of the latter figures.

Prudent Monetary Policy
We saw inflationary and property market risks as among the key reasons the People’s Bank of China (PBoC) had paused cutting interest rates and reserve requirement ratios (RRR). Since then, it has become even clearer that PBoC will not cut rates further, as the government calls for “prudent monetary policy” this year; maintaining price stability has become a greater priority this year.

Inflation Target Lowered to 3.5%
In last year’s NPC meeting, the government’s tone clearly shifted from inflation to growth; but this year the government tightened its reins on price pressures and lowered its official inflation target from 4% to 3.5%. As the nation heads further down the path of recovery, inflation figures towards the end of last year started to rebound (albeit remaining at controllably low levels). A potential revival of commodity prices and the recent gains in property prices may contribute further to inflationary pressure. That said, a lower inflation target does not necessarily equate to a tightening policy stance. Given that last year’s inflation was at just 2.6%, a 3.5% inflation target still grants the nation considerable room for upwards movement. Thus we don’t think investors should be overly concerned with inflation or policy tightening.

However, since mid-2012, property prices started to regain upwards momentum, consistently recording month-on-month increases. Controlling the increase in property prices proves to be one of the largest obstacles the government faces.

Will the Latest Property Measures be Effective?
On 1 March 2013, the government announced new property market curbs in a bid to control the property price increases. The measures include:
• 20% capital gains tax on existing home sales
• Higher mortgage down payments and interest rates on second homes
However, given that the government has still yet to provide further details on these two proposed measures, it is still not clear what the effects on the property market will be. Since the announcement, people have flocked to purchase property before the new restrictions come into effect, pushing up sales and prices. On the other hand, equity markets bore the brunt of the news, with developers hurt most. That said, it is important to note that (from what the government has said), the new tax is only applicable to existing home sales, in that case we may see buyers switch to the primary property market, leaving launch prices firm, which should benefit developers.

All in all, it is clear that the central bank will not be as accommodative going forward. Aggressive measures such as interest rate or RRR cuts may be practically off the table, but liquidity management measures may still come to play. Loose monetary policies were one of the factors we believed would stimulate the equity markets last year but we don’t think the policy stance shift hurts China’s outlook either. First, considering the relatively strong trade figures in the recent two months, China’s economic situation is clearly stronger than it was last year. Second, the focus has merely shifted somewhere else; now the government has put an emphasis on “proactive fiscal policy”, which will have positive longer-term benefits for the nation. Fiscal policy leaning towards an expansionary stance will help counter less assistance coming from the central bank.

Proactive Fiscal Policy As A Long-term Key Driver
During the NPC meeting, emphasis was placed on implementing “proactive fiscal policy” and we believe this will be the key stimulus to the Chinese economy and markets this year. One of the key aims to be addressed is the adjustment in the distribution of national income, in attempt to narrow the gap between the rich and poor. Thus, much of the additional spending will be allocated to social programs. For instance, the health care system reform will be enhanced and health care spending will see the largest growth rate among other key areas of spending, budgeted to grow 27% year-on-year, as opposed to the previous 16% growth. Social programs of this sort will help promote growth in income for the middle class and hence consumption, in line with the nation’s long-term goals of shifting away from overreliance on exports and towards domestic consumption.

To accommodate for increases in fiscal spending, the government raised the fiscal deficit target from the RMB850bn budgeted for 2012, to RMB1.2tn for 2013, which is about 2% of GDP. The RMB1.2tn in deficit will consist of a central government deficit of RMB850bn plus RMB350bn in bonds which will be issued on behalf of local governments. In spite of the sizable increase in the fiscal deficit, China’s government debt issues are still far from worrying. A fiscal deficit of between 2-4% of GDP is still considered healthy and sustainable on international standards. Plus, China’s debt-to-GDP ratios are also at safe and relatively moderate levels compared with other emerging economies, let alone other developed economies (see Chart 2).

Chart 2: Emerging and Developed Economies Debt-to-GDP Ratio In 2012

Is This Bad News for Chinese Equities?
Chinese equities have not reacted too well to the latest developments in China, as investors become concerned over the possibility of tightening monetary policies and further property market curbs. We agree that inflation and property market risks have taken a more prominent spotlight in China’s near-term outlook, but other positive factors are still supportive of the market’s long term outlook. First, external conditions have continued to improve, boosting China’s exports growth in the first two months of 2013. Continued recovery also means that loosening monetary policy would not be necessary, even if inflationary risks were less of a concern. Secondly, long-term economic prospects are promising; especially with the active role the government continues to play in rebalancing the core economic drivers.

Finally, valuations remain at large discounts compared with historical and fair levels, with the Hang Seng Mainland 100 index’s 2013 estimated PE at 9.3X (as of 26 April 2013), below its fair value of 13X. A-shares market valuations are also attractive, as the China Securities Index 300’s 2013 estimated PE at 10.3X, below its fair value of 14X (as of 26 April 2013). Thus, we continue to maintain a positive outlook on the Chinese equity markets.

Yeoh Mei Kei is a Senior Research Analyst at

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