Puzzling China: three pieces of the jigsaw

Bryan Collins
Bryan Collins
Portfolio Manager, Fixed Income8 March 2018

China's repeal of presidential term limits has attracted headlines, but this is just one of three key developments in Asia’s largest economy. These could be the first few pieces of the “China jigsaw puzzle” and we will likely get more pieces of the puzzle to play with over the next few months. What are these three developments and what are the implications for investors in the region?

1. Repeal of presidential term limits

This means the President and Vice President can stay in power longer than 10 years. This proposed change is yet another demonstration that President Xi has established full power in the Communist Party which provides a stable political backdrop for further reforms. This indirectly indicates Xi is very likely to stay at his position after 2023, which will allow the government to take a longer-term view on policy and regulation settings as well as potentially deeper reforms. On the flip side, “key man risk” is now firmly attached to China, one of the world largest economic and political powers.

2. Liu He may become the new People’s Bank of China (PBOC) Governor

Liu could be appointed as the new PBOC governor and Vice Premier of the State Council and be in charge of China’s economy and the financial sector. His control across both economic and financial sectors in China would allow for a more holistic approach and lead to financial sector reforms which entail macroeconomic considerations. In addition, PBOC could potentially evolve from a “policy implementer” to a more effective “policy marker”. Currently, Liu He is the Director of the Central Leading Group (aka Xi’s Economic think-tank), the driving force behind the structural reform policies since 2013. If Liu becomes the new PBOC Governor, we expect tight financial regulation to remain whilst monetary policy and the PBOC’s interest rate policy would likely be neutral, yet flexible, as China delivers sound but moderating economic growth.

3. The Third Plenary session of the 19th National People’s Congress (NPC) brought forward

This is the first time the Third Plenary session has taken place early in the year and right before the annual NPC in early March. We believe this session will focus on personnel changes for senior positions in various government agencies, such as the PBOC, China Bank Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC) and China Securities Regulatory Commission (CSRC) or even more. This could help tackle the fragmented regulatory frameworks across different financial sub sectors and a super regulator could emerge.

Piecing it all together

China remains focused on tackling its systemic risks and excessive leverage; the measures above will provide political stability and control to manage these risks better. This strong ‘willingness and ability’ will support policy continuity, however recent regulatory tightening is putting pressure on onshore funding costs and naturally on some Chinese borrowers. Therefore, additional onshore benchmark rate hikes could be detrimental to the generally constructive wider outlook. We expect onshore government bond yields to remain around their current levels for the first half of this year and potentially be lower in the second half, which could present an interesting cross market opportunity for global investors.

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