Financial Reform Seen as Growth Source

CHINA - Report 24 Apr 2014 by FAN Gang and Chunyang Wang

Executive Summary

Prime Minister Keqiang Li has announced a series of small-scale stimuli to address the economic slowdown, such as cutting the enterprise tax, and stimulating private lending. The new direction is in sharp contrast to the 4 trillion yuan stimulus undertaken at the end of 2008, which was heavily criticized for the high inflation that accompanied it.

The yuan has been depreciating against the dollar since January 14th, and hit a seven-month nadir of 6.225 on April 21st. Accumulated depreciation over this period was about 3%. This is naturally linked to domestic slowdown, but also seems to correct for overvaluation driven by massive hot money inflows.

GDP expanded 7.4% y/y in Q1, its lowest rate for six quarters. Value added for all state and non-state industrial firms with annual turnover of more than 5 million yuan increased 8.7% y/y in Q1, down 1.3 pps from Q4 2013. Domestic demand also slowed. Retail sales of social consumption goods in Q1 rose 12% y/y in nominal terms, down 1.5 pps from Q4.

Slowdown has hit trade. Exports fell -3.4% y/y in Q1, partly due to 2013’s large base number. Imports grew 1.6% y/y in Q1, down 5.6 pps from Q4. All money and credit growth indicators have decreased. M2 rose just 12.1% y/y in March. Moreover, M0 grew at its lowest rate since 1991, save for the Spring Festival period.

The new government seems to be searching for a new growth path. Though the economy achieved tremendous growth over the past 10 years, high inflation and housing prices were also heavily criticized. The new government has abandoned the old way of stimulating the economy, by loosening the monetary base or using a large stimulus package. It now wants to pursue financial reform, to make loans more available to private enterprises, and to cut taxes, to give firms more reinvestment funds.
At the Bo-ao forum on April 10th and 11th, Li said China would promote a Shanghai-Hong Kong stock exchange connectivity mechanism. Other key issues heatedly debated were Internet finance and private banking. We view these financial reforms as a new source of economic growth, though prudential regulation will still be necessary. We predict that reforms should make a 7.5% of GDP growth target achievable this year – and in this we are less pessimistic than other analysts.

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