Although the lawyers are still ironing out the details, the last days of 2019 saw a Phase One trade deal sealed between China and the United States. The trade war is by no means finished and further skirmishes around technology leadership are likely to go on, but the dispute has certainly cooled.
While trade dominated the headlines in 2019, it meant that investors overlooked a series of profound changes to the running of China’s economy that will likely flow well beyond 2020.
Firstly, the reforms to the country’s financial sector outpaced reforms to the overall economy. The relaxation of foreign ownership limits in securities, futures and fund management firms, while a concession to the trade discussions, ought to deepen the underlying trading of financial assets.
However, even these rule changes were surpassed by the reforms the People’s Bank of China made to the loan prime rate (LPR) in 2019. In August, the PBoC “tweaked” the setting of its long rates by introducing a monthly LPR setting, including one- and five-year rates based on the average from 18 lenders, including two foreign ones. This succeeded the PBoC’s original “daily fix” and forces corporate lending rates to follow market rates.
This was quickly followed by requesting the banks to use the newly released LPR in a minimum of 30 percent of their loan issuances before the end of September, 50 percent by December, and 80 percent by March 2020. It is also required the banks to do away with the implicit floor in establishing lending rates in order to reduce real interest rates.
In essence, the PBoC is forcing the banks to bring their lending rates in line with their borrowing rates via the medium-term lending facilities (MLFs).
Second, as the US Federal Reserve began to cut interest rates through 2019, the Chinese central bank was able to ease policy by lowering the reserve requirement ratio (RRR) for banks and relaxing rates through MLFs. Interestingly, it was not accompanied by significant yuan weakness and foreign exchange reserves were virtually unchanged last year. Hence, this shows that the authorities are able to accommodate monetary policies without necessarily fearing a relapse in the currency.
Third, tax reforms were implemented to help boost consumption rather than “blanket” government fixed asset investment spending to underwrite the economy. While the tax changes will initially have a low multiplier effect on the economy versus the older-style “pump priming”, the duration of the easing will tend to be longer.
Fourth, the authorities have allowed both local banks and corporates bonds to default at unprecedented rates. While the PBoC has had to ensure sufficient liquidity within the financial system to permit this to occur, the fact they are allowing the financial system “to clear” is a healthy one and should be welcomed by investors. Moreover, there is little evidence that the authorities wish to revive the shadow financial system just to encourage growth.
Fifth, in November, the US-China Economic and Security Review Commission (USCC) published its annual report to the US Congress. Irrespective of the US-China trade settlement, there is a growing scrutiny of capital raising by China in the US. The recent changes to the weighted voting rights structure rules in Hong Kong ought to mean that a number of Chinese issuers will simply do a secondary listing in the city. The China ADR (American depositary receipt) market will ultimately move to Hong Kong.
Lastly, China has not relinquished hopes of meeting domestic demand via domestic production. Indeed, ahead of the phase one trade agreement, the Chinese authorities ordered all government and public offices under the directive “3-5-2″ to remove foreign computers and software within three years. The underlying details are aggressive, with the replacement of hardware running at 30 percent, 50 percent and 20 percent annual rates by 2022. The “3-5-2″ could be interpreted as another sign of China’s desire for self-sufficiency in line with its China 2025 vision.
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