China - Supply-Side Reform Update: Pace To Vary For Different Measures

BMI View: We expect Beijing to hit its capacity cut targets for the steel and coal sectors before year-end. The government will also make some progress in controlling leverage growth. Beijing will also continue to reduce costs for companies in China. However, we expect the government to make little progress in reducing inventory levels in the property market as it will focus more on maintaining the stability of the market over the coming months.

In our view, the success of different areas of supply-side reforms will continue to diverge over the coming quarters. Notably, we believe that the Chinese government will hit its capacity cut targets for steel and coal before the end of 2017, but will not be able to prevent a rise in the overall debt level in the economy. Beijing will also likely play down on its plan to reduce inventory levels in the property market and instead shift its focus towards maintaining stability in the market. Meanwhile, cost cutting measures will continue to progress at a steady pace in H217.

Beijing To Hit Capacity Cut Targets Before Year-End

We expect the government to hit its capacity cut targets for the steel and coal sectors before the end of 2017. According to the National Development and Reform Commission (NDRC), the country reduced crude steel production capacity by 42.4mn metric tonnes by the end of May, which was equivalent to 84.8% of the target for 2017; coal production capacity has also been lowered by 97.0mn metric tonnes by May, which was approximately 65.0% of the annual target. Given the progress made in H117, the government will likely be able to hit its target much earlier than originally anticipated. Meanwhile, we also note that the government will face significantly less pressure to cut capacity as it is ahead of schedule. This suggests that fewer workers will likely be laid off in H217, which could lower the fiscal burden on local governments in terms of supporting those unemployed.

Controlling Debt Growth Instead Of Deleveraging

We expect Beijing to make some progress in controlling debt growth in the economy, as the central bank continues to tighten credit conditions. Overall, Beijing has not successfully deleveraged the economy over the past few months, and with total social financing stock as a share of GDP coming in at 213.1% in June (versus 207.9% a year prior). TSF stock grew by 12.8% y-o-y in June, versus a nominal GDP growth of 11.4% y-o-y in H117, suggesting that the overall debt level in the economy was still rising in H117. However, we note that the gap between TSF growth and nominal GDP growth has narrowed significantly since January 2017, reflecting slower rate of debt growth. As the central bank will likely have more room to tighten credit conditions further on the back of strong economic performance in H117, debt growth is likely to slow further. In addition, we believe that Beijing will remain committed to reforming state-owned enterprises (SOE) in the form of promoting mixed ownership reforms (see 'Commitment To SOE Reforms Still Intact', June 20), which also bodes well for controlling debt growth. A rapid deleveraging is still unlikely though, as the central government will prioritise economic stability instead of deleveraging ahead of the 19th National Congress of the Communist Party of China in H217.

Market Stability To Outweigh Inventory Reduction

We believe that Beijing will focus on maintaining stability in the property market instead of its initial objective of reducing levels of inventory. Beijing's decision to reduce downpayment requirements for property purchases helped to reduce inventory levels in Tier 1 and 2 cities, though it came at the cost of a significant surge in property prices, resulting in the formation of asset bubbles. In fact, we estimated that prices of new residential buildings in Tier 1 cities rose by 50.7% from December 2014 to June 2017, while total gross areas for sale dropped by 45.0% during the same period.

As such, we expect the government to play down its plan to reduce inventories in Tier 1 and 2 cities over the coming quarters and to focus instead on containing risks of potential price corrections in the market. Indeed, on April 6, the Ministry of Housing and Urban-Rural Development announced that city governments needed to increase the supply of land if the inventory levels in these cities were low. The increase in land supply, together with measures adopted by different city governments to curb sales (see 'Property Curbing Measures To Weigh On Economic Growth', October 26 2016), will continue to act as a drag on the reduction in inventories. That said, we still expect inventory levels to decline in some Tier 3 cities such as Dongguan and Wuxi, as these cities are not required to increase land supply increases and not subject to purchase restrictions, and they may benefit from hot money flowing out of Tier 1 and Tier 2 cities (see 'National Housing Market To Soften', July 6).

Cost Cutting Measures To Continue At A Steady Pace We expect Beijing to make steady progress in cutting costs for companies. Unlike other supply-side reform policies, cost cutting measures will unlikely face significant resistance from vested interest groups, which will likely ensure a smoother adoption of these policies. Moreover, relatively stable government revenue growth in H117 will also allow the government to continue to cut taxes and other administrative costs for businesses. Indeed, government revenue expanded by 9.8% y-o-y in H117, which marked an improvement from a full-year growth rate of 4.5% in 2016, and outperformed Beijing's 2017 target of 5.0%. The ongoing cost cutting measures will help to improve the efficiency of the economy in the long term (see 'Tax Cuts To Improve Market Efficiency', April 21).

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