What to expect next year for China and Hong Kong?

What to expect next year for

China and Hong Kong?

Alicia Garcia-Herrero Chief Economist Emerging Markets – BBVA Research

January 15, 2014

2

Outline

1. Global Outlook:

Recovery proceeds with downside risks gradually diminishing

2. China Outlook:

Growth momentum continues, but with rising fragilities

3. Hong Kong Outlook:

Adapting to a changing environment amidst medium-term challenges

Global Outlook

Global GDP growth (%) Source: BBVA Research

• Our current outlook incorporates an improvement in global growth as emerging markets join the ongoing pickup in advanced economies.

• Risks are still biased to the downside but have declined in recent months:

the eurozone has begun to recover

US fiscal wrangling appears to be over

QE tapering has been well received by the markets, and vulnerable countries are preparing

3

4.02.8

-0.4

5.2

4.0

3.32.9

3.6

-2

-1

0

1

2

3

4

5

6

2008 2009 2010 2011 2012 2013

(f)

2014

(f)

2015

(f)Advanced economies Emerging economies

Global growth

A recovery with risks diminishing

GDP growth (%) Source: BBVA Research and IMF

Global recovery continues to on the back of advanced evonomies, with emerging

economies now joinging. Upward bias to US projections.

In emerging markets, vulnerability to a less favorable global liquidity outlook must still be

monitored

Nevertheless, advanced economies are vulnerable to tighter financial conditions. In the

eurozone, risks remain from AQR and wrangling over banking union

4

3. 32. 9

3. 6

2. 8

1 . 6

2. 3

-0. 6 -0. 4

1 . 1

5. 0 4. 85. 2

-2

-1

0

1

2

3

4

5

6

7

8

2012

2013

2014

2012

2013

2014

2012

2013

2014

2012

2013

2014

W orld US E MU BBVA -E AGLE s

Current forecasts

5

Outline

1. Global Outlook:


2. China Outlook:




6 6

• Fears of a hard landing in 2013 did not materialize: Q3 GDP rose to 7.8% y/y, and momentum continues

• Growth has picked up due to improved policy clarity, mini stimulus measures, and improving external demand.

• Still, caution is in order on the growth outlook for 2014 given headwinds from financial fragilities: growth momentum appears to have slowed somewhat in December

GDP growth bottomed out in Q2 Source CEIC and BBVA Research

35

40

45

50

55

60

65

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

Jun-

09

Sep

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Mar

-11

Jun-

11

Sep

-11

Dec

-11

Mar

-12

Jun-

12

Sep

-12

Dec

-12

Mar

-13

Jun-

13

Sep

-13

Dec

-13

Index

02468101214161820

% yoy

GDP growth (RHS) NBS PMI (LHS) Industrial production (RHS)

China’s recovers slowly

7 7

Inflation not really a problem

• Inflation remains contained, falling to 2.5% y/y in December on easing food prices, below the 3.5% target

• PPI deflation has been eased further to -1.4% y/y

• Medium-term inflation is likely to be in the 3.5-4.0% range on higher wage growth

… while PPI deflation remains Source: CEIC and BBVA Research

Inflation moderated on easing food prices Source CEIC and BBVA Research

% yoy

-2-1

01

234

56

78

Jun-

08S

ep-0

8D

ec-0

8M

ar-0

9Ju

n-09

Sep

-09

Dec

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Mar

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Jun-

10S

ep-1

0D

ec-1

0M

ar-1

1Ju

n-11

Sep

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Dec

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Mar

-12

Jun-

12S

ep-1

2D

ec-1

2M

ar-1

3Ju

n-13

Sep

-13

Dec

-13

Non-food Food CPI Inflation

-10-8-6-4-202468

1012

Jun-

08S

ep-0

8D

ec-0

8M

ar-0

9Ju

n-09

Sep

-09

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Mar

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Jun-

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ep-1

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ec-1

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ar-1

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n-11

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Mar

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Jun-

12S

ep-1

2D

ec-1

2M

ar-1

3Ju

n-13

Sep

-13

Dec

-13

Producer Price Index Consumer Price Index

%

8 8

The external environment supportive

• Exports are improving on stronger demand from the US and EU

• The trade surplus remains substantial, and reserves picked up in the third quarter

Export growth has stabilized and reserves are still rising Source: CEIC and BBVA Research

USD trn

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Feb-

07M

ay-0

7A

ug-0

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Foreign reserve (LHS) Exports (RHS) Imports (RHS)

% y/y

9 9

RMB continues to strengthen

The pace of RMB appreciation has resumed… Source: Bloomberg and BBVA Research

• Capital inflows and a weak US dollar have led to a faster pace of RMB appreciation of late

• Will there be another widening of the band?

• The RMB is still undervalued, and is likely to appreciate by 2-3% per year against the USD in nominal terms

…leading to losing external competitiveness Source: BIS and BBVA Research

USD/CNY

6.00

6.05

6.10

6.15

6.20

6.25

6.30

6.35

6.40

6.45

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep

-12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep

-13

Nov

-13

Jan-

14

Trading band Band widening USD/CNY spot

95

1 00

1 05

1 1 0

1 1 5

1 20

Jan

-11

Ma

r-1

1

Ma

y-1

1

Jul-

11

Se

p-1

1

No

v-1

1

Jan

-12

Ma

r-1

2

Ma

y-1

2

Jul-

12

Se

p-1

2

No

v-1

2

Jan

-13

Ma

r-1

3

Ma

y-1

3

Jul-

13

Se

p-1

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No

v-1

3

R E E R NE E R

Index 201 1 Jan = 1 00

Appreciation

10 10

• Potential growth will decelerate in the coming decade, to 6½% by 2020, from +8% at present

• The decline is due to lower TFP, decelerating investment, and stagnant labor force growth

• These estimates are a “good” scenario, based on continued progress in economic reforms and rebalancing

Declining potential growth … Source: BBVA Research

So why worry? Decelerating potential growth

Contribution by factors TFP Capital Labor

Potential growth

real growth

1981-1990 2.9% 5.5% 1.5% 9.8% 9.3%

1991-2000 2.4% 5.5% 0.7% 8.7% 10.5%

2001-2010 3.8% 5.2% 0.3% 9.3% 10.2%

2011-2020 2.8% 4.8% -0.2% 7.5% --

… as the contribution of labor and total factor productivity diminish Source: BBVA Research

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017

2020

TFP Capital Labor

Real Growth Potential Growth

Projection

11 11

The end of a growth model

• An unhealthy mix of growth at present, too heavily weighted toward investment

• Sustaining growth in the medium-term will require slower investment growth and faster private consumption

• Policies: facilitating urbanization and growth of household income, improvements in social safety net, market reforms , boost to consumer finance, currency appreciation

• Third Plenum outline for reforms encouraging but many questions on implementation and contradictions

Rebalancing will take time Source: CEIC and BBVA Research estimates

-5-3-113579

1 11 31 5

20

07

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08

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09

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14

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20

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20

17

C ons umption Inves tment Net E xports GDP growth

% yoy

12

No evidence of rebalancing so far

• Rebalancing has hardly begun, but if you look hard enough, there are some signs

• Narrowing current account balance, stabilizing consumption and investment, growing services sector

… and current account surplus has narrowed Source: CEIC and BBVA Research

Rebalancing toward domestic consumption remains disappointingly slow Source CEIC and BBVA Research as % of GDP

0

2

4

6

8

10

12

200

0

200

1

200

2

200

3

200

4

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5

200

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200

9

201

0

201

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201

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2013

Q3

%

25

30

35

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45

50

2000

2001

2002

2003

2004

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2009

2010

2011

2012

2013

Private Consumption Investment

• The latest audit of local government debt shows an increase to RMB 17.9 trillion at end-June 2013

• A clean-up of local government debt may require central government funds, and bank write-offs

• Dealing with the local government debt problem is a priority for 2014

Local government debt has risen Source: BBVA Research

Local government debt to weigh on bank profits

13

% of GDP

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10

20

30

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50

60

70

80

2010 2012 est 20131H est

Local Government Financing Vehicle DebtLocal Government Agency DebtBank Restructing CostCentral Government DebtTotal debt

Shadow banking also poses risks to banks

• The size has grown rapidly in recent years as banks circumvent tightening regulations

• The involvement of banks in shadow banking activities could eventually impact their balance sheets

Shadow banking activities have risen… Source: Wind, CEIC, PBoC and BBVA Research estimates

…leading to an increase in the size of the shadow banking sector in the economy Source: PBoC and BBVA Research

%

0

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20

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50

60

2010

2011

2012

GDP Bank asset

RMB trn

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5

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15

20

25

30

35

40

2010

2011

2012

2013

est

WMPs Trust Company productsEntrust loans (liability side) Bank acceptance (liability side)Private lending (liability side)

14

• As a share of GDP, China’s corporate debt is high by international standards • High corporate debt may constrain growth and weigh on bank asset quality

China’s corporate sector debt as a share of GDP is high by international standards Source: BIS, Haver and BBVA Research

Corporate sector debt also a concern

%

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Czec

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Afric

aInd

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Indon

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Mexic

o

Corporate Household15

16 16

Home prices still raising

• Accelerating housing prices have kept the focus on housing bubbles and affordability

• The government’s tightening measures and home purchasing restriction are expected to remain in place

• Rising housing prices are a key factor for the authorities’ reluctance to ease monetary policy

Housing prices and transaction volumes rise sharply, led by tier 1 cities Source: CEIC and BBVA Research

Is the recent rise in China’s housing prices reminiscent of international bubbles? Source: NBS and BBVA Research

-20

-15

-10

-5

0

5

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15

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25

May

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-160

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Overall BeijingShanghai ShenzhenTrading Value (RHS)

% yoy % yoy

50

75

1 00

1 25

1 50

1 75

200

225

250

275

300

0 8 1 6 24 32 40 48 56 64 72 80 88 96

S pain 1 997=1 00 US 1 997=1 00

China 2000=1 00 Japan 1 976=1 00

period T

17

Outline

1. Global Outlook:


2. China Outlook:




Growth momentum picked up modestly Source: CEIC and BBVA Research

Hong Kong’s GDP growth slowly picking up

18

• After a disappointing 2012, Hong Kong’s growth picked up to 3.1% (est.) in 2013

• Exports and robust private consumption have been the growth leaders

• We expect growth to rise further in 2014 and 2015 (3.7% and 4.0% respectively) on sustained growth

in China and an improving external environment

%

-2-1

012

345

67

2010

2011

2012

2013

2014

Consumption Investment Net Exports GDP growth

%

-2

0

2

4

6

8

10

Feb-

10

May

-10

Aug

-10

Nov

-10

Feb-

11

May

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Aug

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Nov

-11

Feb-

12

May

-12

Aug

-12

Nov

-12

Feb-

13

May

-13

Aug

-13

Nov

-13

CPI: Food CPI: Non-Food Headline CPI

Inflation remains on the high side Source: CEIC and BBVA Research

Inflation remains high38

19

• The linked exchange rate regime limits Hong Kong’s scope for an independent monetary policy, and currency appreciation pressures show up as domestic inflation

• Headline inflation has remained high (4.3% in 2013), driven by food prices and housing costs

• We expect inflation to moderate somewhat in 2014 and 2015 (3.7% and 3.5% respectively) as housing

prices cool

20 20

Labor market remains tight

The unemployment rate remains low and stable Source: CEIC and BBVA Research

Distribution of job vacancies by sector (2013 Q3) Source: Census & Statistic Department and BBVA Research

13.5%

4.9%

7.5%

11.2%

18.3%

19.9%

24.7%

Import or Export, Wholesale & Retail TradesSocial & Personal ServicesAccommodation & Food ServicesProfessional & Business ServicesFinancing & InsuranceReal EstateOthers

Index: 1992 Sep = 100

105

110

115

120

125

130

Sep

-04

Sep

-05

Sep

-06

Sep

-07

Sep

-08

Sep

-09

Sep

-10

Sep

-11

Sep

-12

Sep

-13

0

1

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3

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6

7

8

Real Wage Index Unemployment Rate sa (RHS)

%

• As in other Asian economies, Hong Kong’s labor market has been tight on strong demand and limited labor supply

• The strong labor market has helped to increase wage income and boost private consumption

• However, it has also increased inflationary pressure and resulted in labor shortage in certain sectors

• Minimum wage has risen to 30HKD/hour from 28HKD/hour as introduced in 2011, still below the market level

The property market has begun to cool Source: CEIC and BBVA Research

Property market has been the focus of policy

21

406080

100120140160180200220240260

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

102030405060708090100110120

Overall residential Property price index (LHS)Residential property price index for luxury housing (LHS)Private household affordability ratio (RHS)

Index 1999=100 % of household income

• Property market has cooled over the past year due to macro-prudential measures and expectations of US Fed QE tapering

• The housing market is a source of vulnerability, and is susceptible to an increase in international interest rates

Credit growth remains fast Source: CEIC and BBVA Research

Lending boom has moderated

22

• Over the past few years lending growth has been fueled by housing mortgage demand and loans to mainland companies

• More recently, mortgage lending has slowed, while offshore lending remains strong

2200

2700

3200

3700

4200

4700

Feb-

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ug-0

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b-09

May

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687072747678808284868890

HKD loan-to-deposit ratio (RHS)HKD loan (LHS)HKD Deposit (LHS)

HKD bn %

Mortgage lending has eased Source: CEIC and BBVA Research

% y/y

0

10

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Feb-

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-13

Total LoansLoan for other domestic useLoan for use outside HKOutstanding Residential mortgage

Medium-term challenges in Hong Kong

23

• Vulnerability to external shocks

• Increasing economic reliance on China

• Income inequality: Gini Coefficient 53.7% in 2012

• Rising competition from Shanghai’s as a financial center (e.g., Shanghai Free Trade Zone)

• Ageing population and labor shortages

• Political unrest regarding autonomy and 2017 universal suffrage

High Gini Coefficient in Hong Kong Source: CIA and BBVA Research

%

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60

Hon

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Mex

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Taiw

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What to expect next year for

China and Hong Kong?

Alicia Garcia-Herrero [email protected]

Thank you for your attention! Questions welcome

25 25

Appendix: China: Near-term growth outlook • Growth will slow in 2013-14 as the government tackles financial fragilities posed by shadow banking,

local government debt, and rising housing prices

• Downside risks include: sluggish external demand, policy uncertainty, and slowing potential growth

Baseline

2010 2011 2012 2013F 2014F

GDP growth 10.4 9.3 7.8 7.7 7.6

CPI (avg) 3.3 5.4 2.6 2.6 3.3

CNY per USD (eop) 6.62 6.30 6.23 6.05 5.90

Benchmark interest rate (eop) 5.81 6.56 6.00 6.00 6.00

26 26

Appendix Hong Kong: Near-term growth outlook

• Growth will pick up in 2013-14 as 3.1% and 3.7%

• Downside risks include: sluggish external demand and housing bubbles

Baseline

2010 2011 2012 2013F 2014F

GDP growth 6.8 4.9 1.5 3.1 3.7

CPI (avg) 2.4 5.3 4.1 4.3 3.8

HKD per USD (eop) 7.77 7.77 7.75 7.75 7.75

Benchmark interest rate (eop) 0.50 0.50 0.50 0.50 0.50

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