China shifts to ‘quality’ growth as US slips into crisis

beijingwalker · Mar 16, 2023

China shifts to ‘quality’ growth as US slips into crisis

China is suddenly and dramatically a portrait of stability vis-a-vis the banking chaos erupting in the US
By WILLIAM PESEKMARCH 15, 2023

China's newly-elected Premier Li Qiang takes an oath after being elected during the fourth plenary session of the National People's Congress (NPC) at the Great Hall of the People in Beijing, China on March 11, 2023. Image: Pool / Twitter / Screengrab
As political split screens go, the one playing out in Washington and Beijing this week couldn’t be more different.

In the US capital, the Federal Reserve and the Treasury Department are scrambling to contain the worst bank failure — Silicon Valley Bank — since 2008. In Beijing, the energy is future-oriented as leader Xi Jinping’s new Premier Li Qiang sets the stage for a burst of supply-side forms.

Or so global investors hope. Xi’s party, after all, is creating a split-screen dynamic inside Beijing, too.

On one, Xi is consolidating power in ways that strengthen his already firm control of the private sector. On the other, Li reassured skeptics that China is prioritizing “high quality” growth.

That, Li said at this week’s National People’s Congress, means policies to raise incomes and increase access to more affordable housing, education and health care.

As one senior Hong Kong banker puts it: “It remains to be seen if new Premier Li and Xi are doing a good cop-bad cop routine in appealing to global investors. Or if Li is making promises only Xi can keep.”

For now, though, Li seems to be getting off to a solid start in shifting the policy tone from regulatory volatility to greater stability. Case in point: a surprise move to retain nearly half of 26 cabinet positions, including People’s Bank of China Governor Yi Gang and Finance Minister Liu Kun.

“The decision helped to reassure markets, as it entails some degree of policy continuity,” says economist Carlos Casanova at Union Bancaire Privée.

Specifically, Casanova says, it suggests the PBOC will continue to provide liquidity support in 2023, which is positive for markets. For now, he adds, that has “temporarily shored up” investor confidence “on the back of developments in the US.”

Casanova notes that “concerns surrounding systemic risks in the banking sector have exerted downside pressures on short-term yields and have led to a re-pricing of terminal rates, resulting in US dollar depreciation.” The idea that Yi is still on the case is an elixir for markets.

Yi Gang will remain as governor of the People’s Bank of China during Xi’s third term. Photo: AFP / Sonny Tumbelaka

The timing of this signal is important. On Tuesday, Moody’s Investors Service cut its view on the entire US banking system to “negative”, a fresh blow to an already reeling sector.

“We have changed to negative from stable our outlook on the US banking system to reflect the rapid deterioration in the operating environment following deposit runs at Silicon Valley Bank (SVB), Silvergate Bank, and Signature Bank (SNY) and the failures of SVB and SNY,” Moody’s said in a report.

Moody’s notes the extraordinary actions taken by the Fed, Treasury and US Federal Deposit Insurance Corporation (FDIC) to backstop shaky banks. The Fed, for example, created a facility to give embattled institutions access to cash. The Treasury Department rolled out US$25 billion to give depositors with more than $250,000 at SVB and Signature full access to their funds.

Yet risks abound, Moody’s warned. “Banks with substantial unrealized securities losses and with non-retail and uninsured US depositors may still be more sensitive to depositor competition or ultimate flight, with adverse effects on funding, liquidity, earnings and capital,” the rating company said.

These risks complicate China’s path to recovery from the “zero Covid” era. One fresh wild card: will the Fed tighten again later this month or signal it might need to cut rates next?

“A lot of people thought that the Fed needed something to break in order to really shift their monetary policy and this may have been that breaking point,” says analyst Daniela Hathorn at Capital.com.

“The fragility of the banking system and the fact that interest rates have affected lenders in the US economy have really come to bear with the collapse of SVB and Signature Bank. This may be the turning point for the central bank to start reversing or moderating monetary policy.”

Analyst Edward Moya at OANDA notes that “obviously, given the market turbulence over the past week, it is no surprise that expectations for the FOMC meeting on March 22nd are all over the place.”

In the meantime, confusion reigns over the direction of US bond yields, the dollar and the wherewithal of American consumers to buy Chinese goods. “The concern is that we could be just seeing the tip of the iceberg,” says strategist Chaoping Zhu at JPMorgan Asset Management.

SVB’s joint venture in China – Shanghai Pudong Development Bank – was quick to insist its operations and liquidity positions are stable. Yet the real fallout for China will come from more US banks falling into trouble. Any whiff of another 2008-like financial crisis also could put the roughly $1 trillion of US Treasury securities that China holds in jeopardy.

As these risks mount, Li in Beijing is signaling that his reform team is hitting the ground running. Importantly, it is focusing on kitchen-table issues to instill greater economic confidence from the ground up. And, economists say, it is working to buttress support for the Communist Party in the wake of “zero Covid” lockdowns that fueled massive protests.

“Most people don’t keep their eye on GDP growth all the time,” Li said on March 13. “What they care more about are things that happen in their everyday life.” Currently, Li added, “our development is focused on providing for people’s basic needs. Going forward, the focus will be shifted toward delivering a life of better quality for the people.”

To many economists, Li is offering the most explicit explanation to date for the “common prosperity” theme Xi began pushing in 2021. Li added that the “key will be making progress on high-quality development,” including fostering stability in prices and employment.

It also means a shift toward more productive development, including supporting a tech boom and emphasizing growth from green industries. And increasing innovation and self-reliance as US President Joe Biden’s White House limits China Inc’s access to vital technologies including advanced chips.

There’s little time to waste, as China’s post-Covid rebound gets off to an unbalanced start. Though top-line growth accelerated in the first two months of 2023, industrial output was less impressive in the January-February period – expanding a slower-than-expected 2.4% year on year.

Retail sales rose in line with expectations at 3.5%, on par with the same period last year. All this “probably reinforces the view that even if we have a sequential upswing on China’s rebound on the back of the reopening, it’s not going to be like a big boom,” economist Johanna Chua at Citigroup Global Markets told Bloomberg.

Even so, the reform platform that Li is telegraphing raises hopes that Beijing’s wealth-destroying crackdown on Big Tech since late 2020 is over.

Li’s pro-innovation reputation precedes his premiership. In 2018, back in his Shanghai party boss days, Li successfully lobbied Tesla founder Elon Musk to build an electric-car factory, Musk’s first overseas facility, in the city.

Years earlier, in the 2010s, Li was governor of Zhejiang province. At the time, he was thought to be close to Jack Ma, the founder of Zhejiang-based juggernaut Alibaba Group. So, it’s hoped, Li’s rise to become Xi’s No 2 augurs well for the high-tech sector’s return to economic prominence.

The fact that most of Xi’s cabinet is staying on suggests Xi’s third term might have little appetite for further clashes with tech entrepreneurs. Nor does the Xi-Li team appear open to a deflationary effort to reduce national debt. The continuity suggested by Yi staying on at PBOC seems proof enough of that, economists say.

In his NPC remarks this week, Li stressed that the private sector now contributes about 60% of China’s GDP and 80% of all employment. But it still lacks commensurate independence and political clout. “Indeed,” Li said, “last year, there were some inappropriate discussions about private entrepreneurs, which made them feel frustrated.”

Investors betting on a less frustrating 2023 from China than the US might now be in luck.