China - Risk Prevention To Remain A Top Priority

BMI View: The National Financial Work Conference held between July 14 and 15 signalled that risk prevention will be China's top priority over the next five years. This is in line with our view that Chinese policymakers will step up their efforts to curb financial risks following a strong economic performance in the first half of 2017.

China posted strong real GDP growth of 6.9% y-o-y in the first half of 2017, which we believe will provide room for policymakers to step up their efforts in curbing financial risks. The twice a decade National Financial Work Conference held between July 14 and 15 offered policy guidance for the next five years, with safeguarding financial stability over the medium-term being a key objective. In our view, the meeting shows that the central government has acknowledged structural issues in the economy and will continue with its regulatory crackdown by upgrading the central bank's financial oversight role and paying closer attention to local government and state-owned enterprise (SOE) financing.

Stronger Role For Central Bank In Financial Oversight

The meeting reinforced the People's Bank of China (PBoC)'s position in macro-prudential management and risk prevention. The stronger regulatory power of the central bank comes from the change to the current regulatory framework that involves setting up the Financial Stability and Development Commission under the State Council. According to PBoC governor Zhou Xiaochuan, the office of the new commission will be set up within the PBoC. Although details surrounding who will lead the commission remain unclear, we expect the move to strengthen the coordination of financial oversight between the central bank and the other three major regulators responsible for banking, securities, and insurance. In addition, the more comprehensive framework will place regulators in a better position to identify potential risks in the financial sector. We therefore believe that the regulators will ramp up the crackdown on the shadow banking sector and other irregular borrowing activities, such as unregulated internet financing, in the second half of the year. In fact, the growth of wealth management products (WMPs) balance has decreased significantly to 8.9% y-o-y in May, from 18.6% y-o-y in Q117.

Local Governments To Be More Accountable For Their Debt

The meeting also signalled that the central government will continue to regulate local government debt financing and will impose permanent responsibility on local officials for their debt. The key themes of the meeting were reiterated at the Politburo meeting that was held on July 24. We have already seen the central government stepping up regulatory crackdowns on local government financing. For example, on June 30, the Ministry of Finance (MoF) posted a statement regarding its crackdown on borrowing irregularities by the municipal government of Zhumadian, a city in Henan province. The local authority used taxpayers' money to repay loans and cover interest payments and billed it as government service procurement. On July 12, the MoF posted another statement regarding its investigation into borrowing irregularities by the municipal government of Huangshi, a city in the central Hubei province. The local finance bureau in the Economic and Technological Development Zone used funds from a local government debt swap to repay its debt to a private company. However, we believe that it will not be easy to control the size of local government debt, given that current system for local government officials be promoted still rely heavily on economic growth performance.

Deleveraging Campaign To Speed Up

Meanwhile, another key theme that came out of the meeting was to expand the ongoing deleveraging drive in the financial sector to the broader economy, with reducing SOE debt and the cleaning-up of zombie companies stated as a top priority. In our view, this indicates that the central government will target the toughest part of the deleveraging push in the coming five years. We believe this can be achieved through forcing bankruptcy, debt-to-equity swaps, initial public offerings, and mergers and acquisitions. In our view, the government's efforts to reduce SOE debt are likely to bear fruit over the coming years, which would help improve the efficiency and long-term performance of SOEs (see 'Commitment To SOE Reforms Still Intact', June 20).

Although the central government has committed to the deleveraging of the economy since the 2015 Central Economic Work Conference, it has not solved the corporate debt overhang problem, especially SOE debt. The non-financial corporate sector accounted for 64.7% of overall debt in China by the end of 2016, according to data from the Bank of International Settlements (BIS). Based on data from the NBS, SOE liability as a share of GDP stood at 118% in 2016. Moreover, based on a report from the National Institution for Finance and Development, SOE debt accounted for 60.0% of corporate debt in the first quarter of 2017. The actual figures may be even higher as hidden debt is often disguised through financing channels such as government guidance funds and fake public-private partnerships.

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