27 Sep 2017/Wednesday   

The world’s second-largest economy may be faring well this year but 2018 is shaping up to be less positive, with progress on reducing debt and industrial capacity proving elusive, according to the China Beige Book.

Although this year still looks “far better” than the past two years, faltering demand signaled by a reversal of the five-quarter commodity rally may be in store for 2018, according to the private survey released Wednesday by CBB International, which collects anecdotal accounts from more than 3,000 firms in a format similar to the Federal Reserve Beige Book.

President Xi Jinping has been overseeing a reassertion of control over the economy and financial system this year, in the lead-up to the twice-a-decade Communist Party leadership gathering scheduled to convene next month in Beijing. With some track record in calling pivot points, the Beige Book report said its survey evidence rebuts some of the key perceptions about the economy’s progress.

(a) Capacity cuts in steel and other commodities aren’t happening in reality

(b) Corporate borrowing continues to rise; deleveraging is a myth

(c) The economy isn’t re-balancing to services from manufacturing

(d) China isn’t reflating in the sense of faster growth, but profits are up

“With the Communist Party Congress just weeks away, leadership can breathe easy,” CBB president Leland Miller and chief economist Derek Scissors said in the report. “The worry is not how the economy is faring now, but where it is headed. Beneath substantial accomplishments lies a potentially darker story for 2018.”

CBB said in its prior report that China’s economy remained strong in the second quarter as the Communist Party sought to prevent any pain ahead of the congress. Policy support, a lack of shocks, and the looming political transition offered a best-case scenario for the economy, they said.

‘True Deleveraging’

Interest rates jumped and borrowing slipped in the second quarter, but that amounted to slower credit growth, not outright deleveraging, CBB said in the report.

In the third quarter, companies borrowed at the second-highest rate in four years, as borrowing costs “nose-dived nationally to accommodate,” CBB said. Corporate borrowing remains robust and deleveraging isn’t yet taking place, according to the report.

“Deleveraging hasn’t gotten off the ground,” Miller and Scissors wrote. “The pain from any true deleveraging lies ahead. And that leaves 2018 hanging in the balance.”

Excess Capacity

While China has said it is cutting excess capacity — which has boosted metals prices — CBB’s survey shows capacity expanded marginally in the third quarter after spiking in the April to June period, the analysts said. “Markets also need to be reminded that capacity cuts are only the first step,” they said. “The payoff is supposed to be lower output, which is nowhere in sight.”

Labor force growth accelerated, with nearly half of the firms adding workers and almost none cutting jobs. That’s a positive before the congress because “if policy makers want to make sharp changes, wise or unwise, they can do so with less political risk,” the analysts said.

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