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Inside China 04 April 2018

Liu He's big brake

Jeremy Stevens

In January 2018, at the World Economic Forum, Liu He – this was before he became Vice Premier, and not quite yet the most import economic policymaker in China – said that the Chinese government would bring debt under control “within three years”. Furthermore, Liu stated that some reforms would “exceed the expectations of the international community”.

Since that speech, China’s government has seen a significant make-over: eight ministerial-level agencies have been axed; several government functions have been merged; and the Party’s grip on the economy, military, and society has tightened. The overhaul also includes the merger of the banking and insurance regulatory agencies – which will now report into the PBoC to improve supervision of the country’s debt-laden financial sector.

In addition, a new agency, to coordinate economic policy, was established: the Central Committee for Financial and Economic Affairs (CCFEA). Chinese President Xi Jinping and Premier Li Keqiang, along with two other Politburo Standing Committee members, Wang Huning and Han Zheng, are members. It is also expected that the new vice premier and reportedly the go-to for all economic affairs, Liu He, will run the committee’s general office. Its priorities and decisions will shape the country’s macroeconomic landscape and trajectory.

The Party could not be clearer about its policy focus for this year: one necessity (the shift to higher quality economic growth); one main task (supply side structural reform); and three battles – dealing with risks in the financial system, alleviating poverty, and countering environmental pollution. The Chinese government has now taken the emphasis off debt-fueled growth.

The message from the first meeting of the CCFEA this week meets our long-standing belief that Xi and his administration view defusing financial risks as the highest domestic policy priority. Not because some debt-to-GDP threshold has been reached, but from various inspections carried out at the institutional level in recent months that revealed material misallocation of capital, which undermines national security: these financial fragilities stunt development, social order and the Party.

Sifting through recent reports and commentary, China now seems to have graduated to the second stage of the deleveraging process. First stage was stability; making sure the financial system services the real economy, improving the relationship between credit and economic activity, and realigning the financial sector to industrial policy. Now: the gradual decline in the macro leverage ratio or, put differently, actual deleveraging.

Guo Shuqing – head of the banking and insurance regulator and highest ranking party official at the PBoC – said as much in early March, stating that last year’s focus was on interbank assets, wealth management products, and off-balance lending. The regulators have made good on that project, as total bank assets growth continues to hit all-time lows, slipping from 8.7% y/y in January to 8% in February.

Akin to the progress made in bringing the banking sector to heel last year, which was spearheaded by Guo, it is reasonable to expect plenty of resources to be devoted to the goal of actually reducing leverage. To this end, the focus will shift to reducing corporate leverage, diminishing shadow banking, cracking down further on illegal financial activity, mitigating real estate bubbles, and bringing hidden debts of local governments onto the books.

These signals are important because China hasn’t deleveraged: so far, debt growth has migrated from corporates to individual households, and overall debt has risen – albeit more modestly. Indeed, an argument can be made that there continues to be a matter of shifting debt between domestic parties. However, it is worth highlighting that Xi Jinping started talking about financial risk in early 2017, following which, material progress has been made. Now, in 2018, Xi is talking about outright deleveraging – and the alignment of policymakers and the institutional scaffolding around them are clearly in place, implying that this may kick off genuine deleveraging.  


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