Simon Daly Blog | China looks set to dramatically increase it's spending on infrastructure | Talkmarkets
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China looks set to dramatically increase it's spending on infrastructure

Date: Tuesday, September 5, 2017 6:01 AM EDT

Summary

With the combination of yuan devaluation and continuing capital outflows, China will be a source of volatility for financial markets in 2017.

Investors shouldn't underestimate China's ability to support its economy with massive fiscal stimulus measures over the medium term.

The recent rout in the onshore bond markets is being exacerbated by the unwinding of collateral agreements.

This article will use various freely available news sources and academic studies to present an unbiased view on issues facing the world's second-largest economy.

China is Kicking the Old Growth Model Back into Action

The Chinese onshore government bond markets have been selling off in tandem with global bond markets following the election of Donald Trump as US President. Investors are speculating that future fiscal spending in the US will lead to an increase in inflation, which will in turn make the US Fed to raise interest rates at a faster pace.

Commodity markets have been rallying since Q1 2016 after China's move to support its ailing economy with a massive credit burst into the state owned enterprises. The economics of a credit burst point towards the initial effects wearing off over time, but investors expect that the central government will follow up this stimulus with massive fiscal spending over the next five years under the One Belt One Road initiative and the 13th Five-Year Plan (Chinese).

China is the world's largest consumer of commodities, and although commodity prices have been traditionally priced in the US dollar, trading on the Chinese exchange has been increasing, driving global price movements in key commodities. On November 11th, copper futures on the Shanghai futures exchange jumped on the strongest surge in volume since trading began in 2004. At the open of trading on the LME in London, futures rose 7.6%, and at the open in New York, prices rose a similar percentage. Prices fell back later in the day in Asian trading to close 1.6% down. In the first two weeks of November 2016, the combined daily transactions on China's three commodity exchanges rose to an all-time high of $226 billion.

 

Much has been made about Trump's 10-year fiscal plan, but there has been relatively little commentary on the effect China's fiscal plans are having on global growth expectations. Under the 13th FYP, China has laid out massive infrastructure development plans which will dwarf the proposed US stimulus measures. There has long been a recognition among investors that China will have to spend at least $2tn per year to keep its economy growing at the minimum 6.5% GDP growth rate that it has set under the 13th FYP. China will likely exceed this figure in 2017 and 2018 in order to forge ahead these plans.

President Xi's Reform Agenda

Some China watchers take a dim view of President Xi's commitments to initiate deep reforms, and they see the credit burst in Q1 2016 as affirmation that the government hasn't found a way to maintain the old carrot-and-stick authoritarian governance model while allowing private enterprises to take a greater role. They take a negative view on commitments to allow market forces to take a more decisive role in China's future. Many see these efforts as being focused on allowing markets to absorb China's excesses rather than being measures designed to allow greater protection for private property rights and more support for private enterprises. Opening up the economy to market forces runs the risk of massive capital outflows as there is a relative scarcity in "sticky" investable assets inside China after years of excess fixed asset investment that has created massive pent-up capital liquidity that flows from the stock market, to real estate, to commodities. With depreciation expectations gathering pace, the PBOC will be intervening aggressively in 2017 to maintain a stable devaluation trend in the yuan.

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