Deleveraging and risk prevention have been the main themes of China's macro policy over the past two years. After eight years of rapid credit growth, the effect of credit on propelling economic growth has been diminishing, and the financial risk began to emerge. Hence, in 2015, the Central Economic Work Conference has set "deleveraging" as one of the important tasks of structural reforms in 2016. In addition, to achieve deleveraging China tends to improve the debt structure while promoting production efficiency and economic growth. Particularly, it tends to raise the proportion of equity capital, and control the leverage level within the manageable range so as to control the financial risk and promote the sustainability of economic growth. Starting from the end of 2016, China has been tightening its monetary policy and strengthens the financial regulation to control the debt level and related financial risks. In 2018, the government also strengthened the restrictions on investment and financing activities of the local governments.
The implementation of deleveraging policies over more than two years has begun to bear fruit. According to “The second quarter report on China's deleveraging process” released by the National Institution for Finance & Development (NIFD), the leverage ratio of the real economy sector has increased slightly. At the end of the second quarter of 2018, the leverage ratio of the real economy, including households, non-financial enterprises, and government departments, increased from 242.1% at the end of 2017 to 242.7%, a 0.6% increase and it basically remains stable. From the perspective of different sectors, the leverage ratio of the household sector is diminishing, with an increase of 2.0% in the first half of year, which is lower than the 2.8% increase in the first half of last year. Leverage ratio of non-financial enterprises and government departments is declining, the leverage ratio of non-financial enterprises has declined from 157.0% to 156.4% (it has been declining continuously since reaching the peak of 160.9% in the first quarter of 2017), and the leverage ratio of the government sector has declined from 36.2% to 35.3%, both of which have decreased by 1.4%. Financial leverage has fallen back to 2014 levels. The leverage ratio of the financial sector measured by the asset side decreased from 69.7% at the end of 2017 to 64.3%, while the leverage ratio measured by the liability side has decreased from 62.9% to 61.6%.
The introduction of the deleveraging policy was based on the context of the previous political and economic environment, whereas all of these have undergone major changes recently. First of all, the external environment, such as the U.S.-China trade war is becoming more and more complicated. Though the United States and China have agreed a 90-day grace period for negotiations, the risk of the trade war has not been eliminated. And even without the trade war, the United States could still wage a technology war against China. For example, since this year, the United States has restricted and cracked down on Chinese technology enterprises and put pressure on its allies to jointly exert pressure on Chinese technology enterprises. The tech war between China and United States could be even more lethal to China. Second, the Chinese economic downturn is obvious. According to the National Bureau of Statistics, China's gross domestic product (GDP) grew 6.7 % (YoY) in the first three quarters of this year. Quarter by quarter, the Chinese GDP growth rate (YoY) in first, second and third quarter were 6.8%, 6.7%, and 6.5% respectively. It should be aware that the 6.5% GDP growth in the third quarter was the slowest in nearly a decade of GDP growth since the first quarter of 2009. If that figure is surprising, the forecasts for Chinese GDP growth in 2019 are likely to be even more chilling. Goldman Sachs had forecast that Chinese GDP growth would slow further to 6.1% in 2019. Moody's cut its forecast for China's economy growth to 6% in 2019 from 6.6% earlier this year. Credit Suisse expects China's economy to grow by about 6% in 2019. According to Chan Kung, the Chief Researcher at Anbound, whether China can maintain the 6% GDP growth in 2019 is still an issue.
In addition, deleveraging also come with some side effects. Li Xunlei, the Chief Economist of Zhongtai Securities and Director of the research institute, believes that the deleveraging process will lead to asset shrinkage, which in turn will lead to liquidity deterioration and capital chain rupture, thus triggering financial risks and even the economic crisis. China has taken preventing economic risks as the first task of the “three tough battles”, while stabilizing asset prices can curb the outbreak of crisis. Stability does not mean not fluctuating at all, but to prevent the drastically changes. The current measures to reduce market interest rates are certainly conducive to stabilizing the assets prices, whereas the interest rates are not the only factor that determining asset prices. Thus, reducing market interest rates is insufficient to solve the problem in depth. Moreover, in the context of credit contraction, the prices of risky assets are easier to be affected by the risk premium. Risk premium can be divided into credit premium and liquidity premium. Therefore, to reduce risk premium, it is necessary to inject liquidity into the market and alleviate the credit risk.
Li also believes that it is not enough for the central bank to provide liquidity at present, and the limited tax cuts alone will not be enough to increase the willingness of enterprises to invest and solve the widespread debt chain problem. The government needs to inject liquidity into the economy at a higher level and intensify efforts to eliminate credit risks. At present, the leverage ratio of the central government is less than 20%, which indicate there is still a lot of room for central government to increase its leverage. From the perspective of the structure of leverage ratio in the United States, after the subprime mortgage crisis in 2008, the leverage ratio of households and enterprises has decreased. In order to deal with the crisis, the government increased leverage sharply for five consecutive years, and the leverage ratio increased from 57.7% at the end of 2007 to 96.6% in 2013. China also needs to optimize the leverage structure in the next stage, that is, the household sector to continue the deleveraging policies; to optimize the income structure of households, namely, to narrow the income gap, and improve the income and welfare level of the middle and low-income groups to expand effective demand. It is therefore necessary to increase the fiscal input from government departments (the fiscal deficit rate needs to exceed 3%) and a reform in government fiscal policy.
Anbound's research team believes that China's macro policies also need to change in the face of significant changes in the domestic and international situation. In order to deal with the risk of economic stall speed, China proposes to implement active fiscal policies and monetary policies, which will inevitably lead to increase its leverage ratio. In the absence of formal announcement of the end of deleveraging, it is easy to be criticized for proposing to increase leverage. However, the current environment and situation are undergoing reverse changes. If macro policies are still stuck in the framework of deleveraging, China may miss the timing of regulation, which is bound to further increase the risk of economic stall speed. According to Anbound’s point of view in the end of 2017, China may need a massive stimulus of RMB 30 trillion - 50 trillion in the future. However, the tone of massive stimulus has been questioned because it is contradicting with the 2018 "deleveraging" policy, many officials said it was not feasible. But judging by the current situation, the tone of policy is shifting in the direction we were suggested. Anbound's "drastic" proposal is a pre-judgment following a rational analysis of China's large economic and social system. China's current economic size is much larger than its time of the “RMB 4 trillion” policy; it is now over RMB 80 trillion. For China's economy under complex circumstances, the core role of large-scale stimulus policies is to expand market space, create more demand by expanding the market, so as to enable enterprises to do business, make money. In our view, this is more important than providing a single capital injection and credit support to enterprises.
Final Analysis Conclusion:
Profound changes have taken place both in China and international environment, which would require China's macro policies to change, and not be constrained by the deleveraging policies.
