China’s Slowdown and Rebalancing

HUANG Yiping

November 7, 2016, Tokyo

Growth moderationsince 2010• Is it a cyclical change or a

trend change?

• L-shaped growth trajectory

China’s annual GDP growth rate (%)

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2000 2005 2010 2015

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Battle betweennew & oldeconomies• The old industries lost

competitiveness

• New industries, such astelecom equipment, largemachinery, robot, internetcompanies, are growing.

New Economy Index (NEI) and official manufacturing PMI. Source: Caixin.

48.5

49

49.5

50

50.5

26

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Aug 2015 Oct 2015 Dec 2015 Feb 2016 Apr 2016

NEI OFFICIAL PMI

(%) (Official PMI)

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China is already aglobal leader indigital finance• Reasons: market demand;

digital technology (mobileterminals and big dataanalysis + lots of ITengineers); and tolerantregulation

• But can China continue leadthe industry, according to theproduct cycle theory ofVernon?

Largest fintech companies in the world 4

Four levels: Highest 100% as the benchmark; tier 1 (red) > 80%; tier 2 (orange) 70-80%; tier 3 (yellow) 60-70%; and tier 4 (green) <60%. Source:Peking University Institute of Internet Finance.

2011 2015

Digital inclusive finance: Convergence

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Labor market remains robust• Wages continue to grow,

except in the mining industry,although the pace slowed.

• Consumption is also holding up reasonably well.

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1980 1988 1996 2004 2012

(CNY, 1978 price)

Real salary Polynominal trend

Monthly wages of migrant workers in China6

Contribution to GDP growth• From export and investment

engines to consumptionengine

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-40

-20

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120

2009-03 2010-09 2012-03 2013-09 2015-03 2016-

Capital formation Net export Consumption

Contribution of consumption, investment and net export toGDP growth, 2009-2016 7

Trade and trade balance

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-20

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2010 2011 2012 2013 2014 2015 2016

Export

Import

Growth (%)

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-4

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198219851988199119941997200020032006200920122015

C/A as % GDP

Growth of export and import Current account balance/GDP

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Consumer spending

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2011 2012 2013 2014 2015 2016

Restaurant

Restaurant accumulated

%

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2013 2014 2015 2016

%ConstructionCarFurniture

Growth of restaurant business (%) Sales of construction goods, car and furniture (%)

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Fixed-asset investment

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2012 2013 2014 2015 2016

FAI Infrastructure

FAI Real estate

FAI Manufacturing

Nominal growth (%)

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2012 2013 2014 2015 2016

National

Eastern

Central

Western

Private sector FAI (%)

Infrastructure, real estate and manufacturing National, eastern, central and western regions

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• Evidence from big dataanalysis

• But is it sustainable?

Is the economystabilizing?

Growth and inflation factors estimated from satellite imageof industrial emission.Source: DeepMacro.com

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Growth sustainability and “risky trinity”?

• “Risky trinity” (BIS 2016):

• Falling productivity

• Narrowing policy room

• Rising leverage

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Rising ICOR• The incremental capital-

output ratio (ICOR) increasedfrom 3.5 in 2007 to 5.9 in2015.

• Stimulus policy won’t be aseffective as before.

• Perhaps the greatest risk isgrowth stagnation?

China’s Incremental Capital-Output Ratio

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1985 1990 1995 2000 2005 2010 2015

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Free fall of privateinvestment• Recent rapid deceleration of

private investment attracted alot of attention.

• Why?

• Bad economy

• Light-asset industry

• Crowding-out

• Statistics

Year-on-year growth of total fixed asset investment andprivate fixed asset investment

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25

2014-01 2014-07 2015-01 2015-07 2016-01

Private FAI Total FAI

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High leverage:Minsky Moment?• M2/GDP = 200%

• Credit growth = 13% p.a.

• Non-financial borrowing/GDP= 170%

Borrowings by enterprise, household and government asproportions to GDP (%)

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China US Japan EuroZone

Korea India Brazil Russia

Enterprise Household

Government

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State advancing, private sector retreating

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2003 2005 2007 2009 2011 2013

SOEs: 90th quantile

Non-SOEs: 90th quantile

SOEs: mean

Non-SOEs: mean

SOEs Non-SOEs

TFP 0.9 1.3

Capital output ratio 1.2 2.4

Profitability 7.6 28.7

Interest coverage 5.0 30.2

Financial cost 3.1 4.5

“The state advancing, the private sector retreating” incorporate leverage in China 16

Economic PolicyUncertainty Index• Why rising SOE leverage and

falling non-SOE leverage?

• Discrimination of ownership, size and industry?

• Economic policy uncertainty

• South China Morning Post; Counting proportions ofarticles containingE*P*U*C

Baker, Scott, Nicholas Bloom, Steven J. Davis, and XiaoxiWang, 2013. "A Measure of Economic Policy Uncertainty for China," work in progress, University of Chicago.

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2003q1 2005q1 2007q1 2009q1 2011q1 2013q1 2015q1

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Effects of EPU oncorporate leverage• Statistical analysis show, an

increase in EPU by onestandard deviation increasesSOE debt-asset ratio by 3 pptand lowers non-SOE debt-asset ratio by 2 ppt

• Divergence is greater wherefinancial policy is morerepressive

Economic Policy uncertainty index (horizontal axis) and debt-asset ratios of SOEs versus non-SOEs (vertical axis).

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Non-SOEs SOEs

Linear (Non-SOEs) Linear (SOEs)

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Strategies for deleveraging

• One, tightening monetary policy (so that to slow borrowing)

• Two, increasing the proportion of direct finance in total financial intermediation

• Three, changing the composition of leverage

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What causezombie firms?• Zombie firms are those

financially unviable butcontinue to operate, relyingon government or banksupport

Factors contributing to the formation of zombie firmsNote: All these coefficients are significant at 1% level.Source: Yuyan Tan, Yiping Huang, Wing Thye Woo, 2016,“Zombie firms and the crowding-out of private investment inChina”, Asian Economic Papers.

Zombie Z1 Z2 Z3Gov intervention -0.08 -0.09 -0.04 -0.08State-owned finance 0.05 0.05 0.08 0.05Market intermediation -0.15 -0.15 -0.18 -0.16SOEs 0.14 0.14 0.17 0.15Collective firms 0.02 0.02 0.03 0.03Capital intensity 0.02 0.02 0.02 0.02Export firm -0.01 -0.01 -0.01 -0.01Firm size 0.02 0.02 0.02 0.02Debt-asset ratio 0.44 0.46 0.36 0.45Establishment date 0.003 0.003 0.003 0.003Fixed asset proportion -0.12 -0.12 -0.11 -0.13Profitability -0.72 -0.85 -0.80 -0.72

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Zombies crowd out private investment

OLS FE 2SLS

Non-zombie dummy *

proportion of zombies

0.013*** 0.012*** 0.041***

Proportion of zombies -0.010*** -0.009*** -0.018**

Non-zombie dummy 0.023*** 0.011*** 0.053*

Firm size -0.001*** 0.009*** 0.013***

Establishment date -0.000*** -0.000*** -0.000

Fixed-asset proportion 0.030*** 0.003*** -0.002

Profitability -0.009*** -0.022*** -0.066***

• Empirical analyses confirmthat zombie firms not onlyraise funding costs for non-zombie firms but also lowertheir investment rates

Determinants of enterprises’ funding costsSource: Yuyan Tan, Yiping Huang, Wing Thye Woo, 2016,“Zombie firms and the crowding-out of private investment inChina”, Asian Economic Papers.

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Only discipline cansave the economyResolving the zombie firms may raise:• Growth of industrial

production by 2.1 ppts• Growth of capital stock by 1.4

ppts• Growth of employment by 0.8

ppt• Growth of productivity by 1.1

ppts

Three strategies for deleveraging: controlling money supply, increasing proportion of equity finance and resolving zombie firms.

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51.456.0

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Zombie Non-zombie Average

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Estimates of growth potentials• All slightly higher than the Lee

estimates, but Lee’s numbers look more realistic?

Economists/Institutions Predictions

World Bank and Development ResearchCenter

2011-15: 8.6%; 2016-20: 7%; 2021-20: 5.9%; 2026-30: 5.0%

Asian Development Bank and Peking University

2011-20: 8.0%; 2021-30: 6.0%

Fang Cai and Yang Lu 2011-20: 7.2%; 2016-20: 6.1%

Justin Lin and Fan Zhang 2011-30: 8.0%actual performance: >7.0%

Jong Wha Lee 2011-30: 5.5%

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Which picture best characterizes the future China?

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Thanks 感谢