From a global macroeconomic perspective, we encourage readers to consider that the world is experiencing an extended, rolling process of deflating its credit excesses. It is now simply China’s turn.
For context, Japan started deflating their credit bubble in the early 1990s, and has now experienced more than 20 years of deflation and very little growth since. The US began its process in 2008, and after eight years has only recently been showing signs of sustainable recovery. The euro zone entered this process in 2011 and is still struggling six years onward. We believe China is now entering the early stages of this process.
Having said that, we believe that Chinese authorities have a viable plan for deflating their credit excess in an orderly fashion. Please stay posted as we will review this multi-pronged, market-based approach in our next column.
For now, let’s turn our attention to the size of the credit excess that China created and why we estimate it to be the largest in the world.
A credit excess is created by the speed and magnitude of credit that is created – if too much is created in too short a time period, excesses inevitably occur and non-performing loans (NPLs) emerge.
To illustrate the credit excess that has been created in China, let’s review several key indicators, including the: 1) flow of new credit; 2) stock of outstanding credit; 3) credit deviation ratio (i.e., excess credit); 4) incremental capital output ratio (efficiency of credit allocation).
The chart below shows the amount of credit created as a percentage of GDP during the five years prior to major downturns globally.
Investments in domestic capital markets via participatory notes (P-notes) have surprisingly surged to 4-month high of Rs 1.78 lakh crore at the end of March despite stringent norms put in place by Sebi to curb inflow of illicit funds. P-notes are issued by registered Foreign Portfolio Investors to overseas investors who wish to be a part of the Indian stock markets without registering themselves directly. They however need to go through a proper due diligence process.
According to Sebi data, total value of P-note investments in Indian markets – equity, debt and derivatives -increased to 1,78,437 crore at March-end, from Rs 1,70,191 crore at the end of February. Prior to that, the total investment value through P-notes stood at Rs 1.75 lakh crore in January-end and Rs 1.57 lakh crore in December-end. In March, investments through the route had touched the highest level since November, when the cumulative value of such investments stood at Rs 1,79,648 crore.
Anyone in mainland China with a lot of money to move — companies foreign or domestic, or individuals — now seems likely to run into the capital controls that the authorities have thrown up in hopes of stopping a sell-off in the currency.
Real estate tycoon Pan Shiyi has given up on selling the Hongkou Soho, a striking Shanghai office tower whose tenants include Japanese electronics group Panasonic. Located just north of the Bund, the city’s iconic waterfront, the building was designed by Japanese architect Kengo Kuma. Pan had been looking to invest proceeds from the sale overseas but sees little hope of gaining approval for that.
Similar cases of apparent official obstruction have surrounded other foreign deals. Online game developer Giant Interactive’s agreed-on purchase of an Israeli peer for 30.5 billion yuan ($4.42 billion) remains under review. Technology group LeEco and conglomerate Dalian Wanda Group have yet to complete their respective U.S. acquisitions of television maker Vizio and TV studio Dick Clark Productions.
Meanwhile, total social financing, China’s broad measure of credit and liquidity, continues rising by double digits. With limited outlets to overseas, Chinese money has nowhere to go but domestic assets.
The world’s largest sovereign wealth fund overcame sluggish markets at the start of last year to deliver a return of 6.9 per cent in 2016.
Norway’s $905bn oil fund was boosted by strong stock markets in the second half of the year with equity investments returning 8.7 per cent. Fixed income returned 4.3 per cent in 2016.
Yngve Slyngstad, chief executive of Norges Bank Investment Management, the manager of the fund, said:
“The return in 2016 was characterised by falling international interest rates in the first half of the year and strong equity markets in the second half. The year began with a downturn in the markets, and uncertainty regarding developments in China.”
The fund had 62.5 per cent of assets invested in equities at the end of the year but is expected this spring to be given permission to increase that to 70 per cent. Fixed income assets accounted for 34.3 per cent and real estate 3.2 per cent.
India’s Tata Sons Ltd has agreed to pay Japan’s NTT Docomo about $1.17 billion in connection with the termination of a joint venture in the South Asian nation, the Nikkei daily reported, without citing its sources.
The deal could be announced as early as Tuesday, the Nikkei reported. Tata Sons and DoCoMo were not immediately available for comments. Tata Teleservices and DoCoMo have been locked in a long tussle over the Japanese company’s move to exit a partnership formed in 2009.
Under the terms of that deal, in the event of an exit, DoCoMo was guaranteed the higher of either half its original investment, or its fair value.
When DoCoMo decided to get out in 2014, Tata was unable to find a buyer for the Japanese firm’s stake and offered to buy the stake itself for half of DoCoMo’s $2.2 billion investment. India’s central bank blocked Tata’s offer, saying a rule change the previous year prevented foreign investors from selling stakes in Indian firms at a pre-determined price.
Docomo proceeded to initiate arbitration in a London court, and won it. Tata was asked to pay a penalty of $1.17 billion, which it has deposited with the Delhi High Court.
Norway’s government has proposed making the biggest changes to the world’s largest sovereign wealth fund in decades, increasing its risk by investing about $90bn more in stock markets and cutting the amount of oil money it can use in the budget.
The $900bn oil fund should be able to invest 70 per cent of its assets in equities, up from the current 60 per cent, as the centre-right government backed proposals by both the fund itself and an expert group.
The shift, which needs parliamentary approval, would be significant for global markets as the oil fund on average already owns 1.3 per cent of every listed company. The increase in equities would come at the expense of bonds, as the oil fund, which has an investment horizon of a century or more, tries to increase its returns.
At the same time, the Norwegian government is aiming to reduce the amount of money from the fund Oslo is allowed to use in budgets. Under the so-called spending rule introduced in 2001, the government is allowed to take up to 4 per cent of the fund each year – which is meant to be equivalent to the real return from investments. This would be reduced to a maximum of 3 per cent in the future under the new proposal, as the outlook for returns has fallen.
India’s economic growth is likely to remain muted in the first quarter of this calender year with the GDP likely to grow at 5.7% in the January-March period amid subdued activity, says a report.
According to the global financial services major Nomura, following subdued growth in the first quarter, a V-shaped recovery is on the cards due to remonetisation, wealth redistribution and the lagged effects of lower lending rates.
“We expect growth to remain subdued in the first quarter of 2017 as the activity level remains below its recent peak,” Sonal Varma chief India economist at Nomura said in a research note. Nomura expects economic growth to remain in a downtrend.
As per the report, from 7.3% GDP growth in the July-September 2016, the October-December 2016 quarter GDP growth is likely to slow to 6% and further to 5.7% in the first quarter of 2017 (January-March).
“We expect GDP growth to slow from 7.3% in Q3 2016 to 6.0 % in Q4 and 5.7% in Q1 2017,” it said.
A new report from Standard Chartered estimates capital flows out of China totalled almost $730bn in 2016, a near-record level.
Analysts Shuang Ding and Lan Shen estimated outflows had moderated in December to $66bn, down from November’s $75bn.
Beneath the headline figure foreign direct investment flows turned positive for the first time in eight months with a $3bn inflow, while non-FDI outflows remained unchanged from the previous month at $69bn.
The analysts estimated December’s outflows brought the annual total for 2016 to $728bn, close to the previous year’s record high of $744bn.
They also estimated China’s foreign exchange reserves had fallen $41bn last month to end the year at $3.01tn as depreciation of the euro, yen and pound against the greenback. That reduced the dollar value of China’s holdings in those currencies by about $13bn.
The government’s decision to demonetise higher denomination currency notes would put downward pressure on India’s growth in the short term that could further delay the recovery in investment cycle.
Given the downside risk to growth and lower inflation, domestic brokerage firm Kotak Securities said the brokerage expects the Reserve Bank of India to cut interest rate by 75-100 basis points.
Flagging off concerns regarding risk to domestic growth, analysts at Kotak Institutional Equities said the very near term disruption due to the cash crunch in retail trade and related activities would be a drag on the GDP growth.
“This will accentuate with likely slowdown in segments such as consumer durables and real estate activities. We note that real estate, retail trade, hotels and restaurants constitute 30 per cent of GDP,” it said.
According to Kotak, the GDP calculations incorporate private companies, which contribute 35 per cent of the overall sales.
In a predominantly cash economy this can lead to a significant slowdown in the SME segment, which will have a bearing on economic growth and investments.
There could also be a potential loss of pricing power in the discretionary products segment, which will be disinflationary.
The brokerage added that the surge in deposits and the consequent increase in the liquidity are expected to significantly boost the statutory liquidity ratio (SLR) demand for bonds.
We have a new governor of the Reserve Bank of India, we have a Monetary Policy Committee (MPC), and we have their first statement on monetary policy. It is tempting to read the tea leaves!
The MPC’s statement, with unanimous support, is significant not only for the cut in the policy repo rate but also for the analysis of the economic situation. The statement has come at the end of the first half of the fiscal year and, therefore, it is helpful to understand the state of the economy at the mid-point of the fiscal year which is also the mid-point of the term of the central government.
On the global economy, the outlook is gloomy. Growth has slowed more than anticipated, trade has contracted more sharply, there is rising protectionism, and “an uneasy calm prevails on uncertainty about the stance of monetary policy of systemic central banks”.
State of the economy
On the domestic economy,
“the outlook for agricultural activity has brightened;
“the industrial sector has suffered a manufacturing-driven contraction;
“inflation excluding food and fuel has been sticky around 5%, mainly in respect to education, medical and personal care services;
“in the manufacturing sector, the persistence of considerable slack…;
“in the external sector, merchandise exports contracted in the first two months of Q2;
“subdued domestic demand was reflected in a faster contraction in imports;
“the decline in remittances and the flattening of software earnings warrants monitoring;
“while the pace of foreign direct investment slowed compared to a year ago, portfolio flows were stronger.”