Mar 22, 2017
Pangoal Institution’s China Economic Report—2016 Review and 2017 Outlook Seeking Growth in Stability and Endeavoring to Control Risks
Pangoal Institution’s China Economic Report—2016 Review and 2017 Outlook Seeking Growth in Stability and Endeavoring to Control Risks

Pangoal Institution’s China Economic Report—2016 Review and 2017 Outlook

Seeking Growth in Stability and Endeavoring to Control Risks

Zhang Ming, Zheng Liansheng, Wang Yuzhe, Yang Xiaochen, Zhou Ji

Abstract: The 6.7% economic growth in 2016 exceeded market expectation, mainly due to the infrastructure, real estate, and consuming sectors. However, due to increasingly serious real estate bubbles, the real estate market demands control once again. The economy has been surging, and the government is dedicated to deleveraging in local government liabilities, corporate liabilities, and the bond market. Meanwhile, mutual reinforcement between internal and external risks has become evident. The RMB has depreciated three years in a row, with its nominal and real exchange rates both in decline.

In 2017, the basic economic goal is to seek improvement in stability. Substantive progress remains to be seen, especially in the private sector, where investment expectation is still far from positive. Administrative control in real estate has not changed policy logic, the policy effect remains to be seen, and market risks are still growing. Economic deleveraging is still under way. The corporate sector requires more deleveraging efforts, and it calls for attention to risk of balance sheet recession. While external uncertainties have been slightly alleviated and the US dollar index shows a remarkable slower growth, the RMB is still in a weak position due to economic fundamentals.

In order to seek improvement in stability, policies in 2017 should provide effective support and mitigate risks. Under the policy of deleveraging, de-bubbling, and risk prevention, monetary policy will become neutral, and liquidity management tools will play a greater role. Given this policy goal, fiscal policies will become more important, with infrastructure construction playing a central role in fending off downward pressure. Overall, the RMB will remain relatively stable against USD, but there will be a conflict between exchange rate stability and foreign exchange reserve consumption. Though increased flexibility of the exchange rate will become a key policy option in the future, it requires determined decision makers.

Control in real estate also needs new thinking. In first-tier and second-tier cities, the increase in land supply will be crucial, and real estate tax prevents excessive transactions and speculations in the market, which necessitates major moves in financial and taxation system reform. The 19th CPC National Congress will be where market expectation primarily lies, as comprehensive economic system reform is a primary motivation for private sector investment.

Although gold and dollar retain their value, cash will still be the top preference. In risk assets, real estate investment risks continue to accumulate, and investment in third- and fourth-tier cities should be avoided; deleveraging in the bond market continues, but rate bonds and high-rating credit bonds have gradually become options. IPO in the stock market is speeding up, but it will not result in market revaluation, and the index will range from 3,000 to 5,000. Market trends will still be structural, with opportunities in military-civil integration, infrastructure, consumption upgrading and medical equipment. Certain stocks in internet, new technologies, media, and PC enjoy structural opportunities.

I. Review of China’s Economy in 2016

1. The economy shows signs of stabilization and recovery, and grows faster than expected

Economic growth in 2016 exceeded market expectation. The 2016 economic data published by the State Statistics Bureau on January 20, 2017 show that based on preliminary calculation, China’s GDP in 2016 reached RMB 74.4127 trillion, an increase of 6.7% in comparable price. In contrast, market expectation in late 2015 or early 2016 was around 6.5% or even as low as 6.2%, and foreign market participants even forecasted that China’s economic growth rate may fall below 6%.

In 2016, China’s economy witnessed stabilization and moderate recovery. From the overall trend, from Q1 to Q3 2016, the national economy had been generally stable, which fully corresponds with judgment of the senior leadership that economic growth will display an L-shape. In Q4, growth rose slightly to 6.8%, showing stabilization and moderate recovery. Based on these market prosperity and leading indicators, microeconomic bodies have indeed pulled through their most trying period.

To confirm that the economic trend is positive, we must also analyze the power structure behind economic growth in 2016. That economic growth in 2016 exceeded market expectation can be mainly attributed to the changes in the driver structure for growth: first, government-led investment offset insufficient private investment; secondly, the contribution of real estate market to economic growth increased remarkably; thirdly, the consuming sector is generally stable. Increased demands for housing and automobiles lead to greater consumption and boosted growth.

2. Real Estate Bubbles Become Increasingly Severe, and the Stereotype of Real Estate Regulation Returns

To stabilize growth, relaxing policies in the real estate market became an important option. Due to the economic downturn, the government stimulated overall demand. Financial and fiscal policies became more positive, and credit supply is on the rise. Since 2016, the central government has set the goals of addressing overcapacity, reducing inventory, deleveraging, lowering costs, and bolstering areas of weakness, and the real estate sector has become one of the key fields for reducing inventory. The self-reinforcing and consistent policy framework of the central government, local government, and real estate sector in reducing property inventory have become a major support for secured growth.

However, the real estate market is heavily bubbled. In the process of policy relaxation, increased credit supply, and market demand expansion, significant structural changes took place in the domestic real estate market, where the housing prices of first-tier cities further influenced second-tier cities. With another round of panic buying, real estate market in first-tier cities returned to a precarious condition, and the bubbles are more evident in first-tier and some second-tier cities.

Regulation in the real estate sector occurred again. As risks accumulate at a faster pace, risky features including high price, high inventory, high leverage, high financialization, and high relevance appeared in the sector. The real economy became increasingly involved with real estate and other intangible sectors. Around the 2016 National Day, the central and local governments introduced regulatory policies on the real estate, attempting to control rocketing housing prices with an administrative approach.

Housing price in first-tier cities (left)

Average housing price in 100 cities

Housing price in second-tier cities

Figure 1 Trend of housing price

Source: wind

3. Facing Evident Economic Leveraging, the Authorities are Determined to Deleverage

Facing increasingly higher leverage rates and heavy indebtedness of the financial system, non-financial corporate sectors, and local governments, deleveraging policies have mainly focused on local government debt, corporate debt and bond market. In general, there has been progress.

In resolving local debt, the central government reduces short-term debt burden of local governments by means of local debt replacement. By the end of September 2016, newly issued local government bond amounted to RMB 1.1347 trillion, accounting for 96.2% of the annual limit. Since the launch of local debt replacement, by the end of September, a total of RMB 7.2 trillion of replacement bonds have been issued by local governments. It is estimated that by various means, the localities have saved an interest expenditure of RMB 600 billion between 2015 and 2016.

With respect to deleveraging in the corporate sector, the government has introduced measures to tackle the high and still fast-growing debt level. Firstly, the central government provided reward and subsidiary funds (a total of RMB 100 billion) to facilitate corporate deleveraging. Secondly, the government introduced relevant policies and measures for debt-to-equity swaps to deal with growing debt in line with market and legal principles. Thirdly, equity financing would be rapidly developed to increase its proportion and effectively lower corporate leverage rate. Fourthly, the central government stresses policy coordination for deleveraging. The asset-liability ratio of industrial enterprises slightly decreased from 56.9% in February 2016 to 56.3% to September 2016, total assets increased by 5.9%, total profit increased by 7.7%, and liabilities increased by 4.7%. Both asset and profit grow faster than liabilities, and the asset-liability ratio expects further slight decrease. By the end of 2016, the asset-liability ratio of 5,000 key industrial enterprises (mainly central enterprises and local state-owned enterprises) fell by 0.1 percentage points to 62.3%, compared with 2015.

The bond market is a representative of the deleveraging efforts in the financial sector. Since 2016, defaults in the bond market have been springing up as a result of earlier leveraging. The lack of rigid payment exposed the risk of credit spread, and tighter regulation began revealing risks in the bond market: credit bond default, limiting government bond futures, and liquidity squeeze in the wholesale market became increasingly clear. The deleveraging process of the bond market is also an adjustment process of balance sheets and even off-balance sheet activities of banks and non-bank financial institutions, and risk exposure of the latter in the exchange market significantly outweighs that in the interbank market.

Settlement price of 5-year government bonds

Settlement price of 10-year government bonds

Figure 2 Trend of price of government bond futures

Source: wind

In August 2016, regulatory authorities began controlling the leverage risks in the bond market. Since the PBoC started reverse repo in the month, liquidity squeeze in the bond market became a kind of “ordinary state,” and December even witnessed a remarkable decrease in price of government bond futures. In the process of deleveraging and removing risks, expected investor return gradually drew closer to that of the real economy. The move of the entire yield curve is also a reasonable market characteristic. It is inevitable in the process of returning to the real economy, which means that the process of repricing formally undervalued credit spread took place in the bond market, and that deleveraging has made some progress.

Total custody /(total custody-balance to be bought back)

6 per. Mov. Avg. (total custody/(total custody-balance to be bought back))

Figure 3 Trend of leverage rate in the bond market

Source: wind and author’s calculations

4. RMB Enters the Third Year of Depreciation, with Nominal and Real Exchange Rate Both on the Decline

In 2016, RMB exchange rate against the US dollar experienced a remarkable depreciation of 6.83%. Starting from Pangoal’s 2016 Spring Report, we have insisted that within a period of time in the future, the RMB will continue to devalue, and that the RMB exchange rate against USD is highly likely to stay in the range of 6.8-7.0 by the end of 2016. On October 10th 2016, the RMB exchange rate against USD exceeded 6.7; on November 11th, the middle rate broke 6.8 and was followed by 6.9 on November 24. The year of 2016 is the third year of RMB’s depreciation against the US dollar, with a high level of 6.83%. The RMB also depreciated to different extents against the Euro and Japanese Yen.


100 Yen-CNY


Figure 4 Trend of RMB exchange rate against major currencies

Source: wind

It is notable that the effective RMB exchange rate or RMB basket exchange rate index also showed signs of depreciation and remained relatively weak. The RMB effective exchange rate depreciated by roughly 5.7%, from 130.27 at the end of 2015 to 122.81 at the end of 2016. For the past decade or so, it is rare that nominal and effective exchange rates both depreciate to a large extent. Meanwhile, the index referring to BIS currency basket and SDR currency basket also declined. Since August 2016, the currency basket index has been in a period of adjustment on a weak ground.

CFETS RMB exchange rate index

RMB exchange rate index (referring to BIS currency basket)

RMB exchange rate index (referring to SDR currency basket)

Figure 5 RMB exchange rate against major currency baskets

Source: CEIC.

II. 2017 Economic Outlook

1. The economy Awaits Progress in Stability, but Substantive Improvement Still Needs Time

Infrastructure investment is still the foundation for steady growth. Infrastructure not only refers to hardware, such as the 165 major projects mentioned in the 13th Five-Year Development Plan, but also software, such as the provision of public goods and services in housing, medical care, elderly care, education, and environment. The key to “stabilization” lies in public-sector expenditure.

While private investment has gone through the most difficult times of this economic downturn, the outlook is still far from positive. A major concern in the fall of private investment growth is whether economic recovery in the past three to four quarters can be sustained, and whether infrastructure investment can still support growth. The endogenous recovery mechanism supported by the private sector is not yet established, and to a certain extent, the contribution of domestic demand and consumption are both passive. From the perspective of long-term sustainable driving force of development, positive expectation of the private sector and increased investment are the key. Private sector investment is critical for progress.

While economic growth in 2016 plateaued at 6.7%, the economy still faces pressure downwards in 2017, and substantive improvement occurs over a long period. Firstly, despite relatively favorable external environment as a result of stable external needs, real recovery nevertheless requires time, and substantive improvement of the export and related sectors remains difficult. Secondly, the price of basic raw materials is still high. As the price of basic raw materials can be imported, positive PPI may pose some pressure to CPI. Overseas production of raw materials is generally in a tight balance, and it is sensitive to downstream demand and the dollar. Thirdly, whether domestic consumption can remain stable remains to be seen, especially given the squeezing effect of continuous high housing price on savings and consumption. Lastly, the corporate sector needs further deleveraging, and the asset-liability ratio in certain industries are still rising, which can be a key constraint to investment in the corporate sector.

2. The logic of Real Estate Control Remains Unchanged, and Policy Effect Remains to be Seen

Amid the harsh control on the real estate industry, investment has never been truly reoriented. Logically, following major real estate control, the influx of funds should decrease remarkably. However, by the end of 2016, this had not happened, and total investment plateaued at a 15% high. The growth of bank credit even increased in Q4 2016. Huge fund influxes are still driven by developers’ confidence in the needs and price of the property market.

Figure 6 Trend of source of real estate investment

Source: wind

However, the logic of real estate regulation is unchanged, and the policy effect remains to be seen. The real estate sector has become a potential tipping point for systematic risks. Due to its high level of financialization and relevance, it may result in degradation of asset quality in financial institutions, unhealthy local finances, or even systematic financial risks. On this account, the government carried out large-scale housing purchase quota policies to control related risks. However, the past three rounds of control proved unsatisfactory, and even weakened government credibility. When residents saw housing prices increase amid constant policy alterations, their satisfaction with the policy and government credibility was negatively impacted. Because no substantive changes occurred from real estate investment, it's hard to say that the policy really worked. If investment funding is a quasi-leading indicator, then the future new construction areas and completed areas may increase following endogenous callback.

Area under construction

New construction area

Completed area

Figure 7 Trend of area under construction, new construction area and completed area

Source: wind

3. Deleveraging Pressure Calls for Attention to Balance-sheet Recession

Deleveraging in the financial sector should mainly be focused on the bond and asset management (AM) markets.

As for the bond market, under the pressure to deleverage, institutions would have to sell their bond holdings, which lowers the market price. This is part of the shift from passive to active deleveraging, typically characterized by a rise in short-term interest rates and bond price plunge, as we previously observed. The leverage operations or fund idling problems are a problem related to asset-liability matching as financial institutions pursue high yields in the middle of an economic downturn.

As for asset management, the media report on The Guidance on Standardizing the Asset Management Business of Financial Institutions on February 23rd may well be the prelude to stronger regulation on AM. The Guidance proposed major measures regarding on-balance and off-balance businesses, managing intermediaries and credit intermediaries, investment scope and limited fields as well as risk control in the AM area. In terms of capital constraint and risk reserve, a key risk control policy in the Guidance is to require AM institutions to establish good capital constraint mechanisms to withdraw 10% of product management fee as risk provision. According to a former requirement of the MPA (Macro-prudential Assessment), off-balance businesses of banks and other financial institutions would be included in the MPA, and we are expecting a mechanism for off-balance capital constraint to be established in days to come. As for the leverage multiples and concentration ratio, the Guidance proposes unified limits on the leverage of structured products so as to control high leverage operations. The market value of a single AM product invested in a single stock or fund should not exceed 10% of the net asset of the product (excluding private equity products); the market value of all AM products invested in a single stock or fund should not exceed 10% of the market value of said stock or the fund size.

Bank WM  Special fund account  Trust plan  Broker AM  Public fund  Private fund  Insurance AM

Figure 8 AM by industrial sectors in China

Source: “China’s AM size: Rmb60tn”, Li Chao, Xinhua News Agency, November 17, 2016.

Progress has been made in deleveraging bond markets and local government debts in 2016. The rising trend of corporate debt ratio has been checked and displayed a slight decrease. However, deleveraging in the corporate sector is still a long term activity. Firstly, the overall debt ratio of industrial enterprises is still at a historically high 62%. Secondly, on a broader scale, the debt ratio of SMEs is even higher and tougher to reduce given a recovering economy. Third, different industries are very different in terms of debt ratio changes. For example, the ratio is rising in coal, petrochemical, and nonferrous metal sectors, which are typically known for overcapacity.

Coal mining and washing, oil and natural gas extraction, black metal mining and beneficiation, nonferrous metal mining and beneficiation, non-metal mining and beneficiation, farm and non-staple food processing, textile, chemical raw materials and products, general equipment, special equipment, electrical machinery, power and heat production and supply, nonferrous metal smelting, black metal smelting

Figure 9 Debt ratio by industrial corporate sectors

Source: Wind

With relatively poor results achieved in deleveraging, the corporate sector faces long-term pressure to adjust balance sheets, which, as a result, may fall into recession. With overcapacity and insufficient demand, private players have seen both their revenue and asset ends worsening. In particular, the price of continuous manufactured goods generally remains at a low level, which contains the product price of some private enterprises to be even lower than product cost. With debt pressure still building, private investors face dual pressure as assets shrink and debt rises. In fact, tumbling private investment might be an indicator of self-reinforcing balance sheet risks. This is the most challenging risk in future economic growth and fixed asset investment.

4. RMB Remains Weak as the USD Index Falls

The RMB exchange rate depends heavily on the USD index. When the index drops, the RMB would be stable compared to USD and depreciate against the basket; when the index grows, RMB would be stable against the basket while depreciating against the USD. The fast growth of the USD index was the most important reason behind the huge depreciation pressure on the RMB against the USD at the end of 2016. In 2017, to keep the RMB’s value against USD stable, it is expected that the RMB exchange rate will still depend on the USD index.

Yet within the current policy framework, it is hardly possible for the USD to regain its momentum from November 2016, when it rocketed from 97.2 on November 3rd to 101.2 on November 18th, a sharp slope rarely seen. This was primarily because growing expectation for inflation led to higher expectation for the Fed to raise interest rates. The yield rate of 10-year Government bond futures grew as high as 2.5%, meaning that the market had expected the Fed to raise interest rates six times (25 base points each time, presumably). However, the US inflation expectation might not be as strong as expected in 2017, and the gap between nominal and effective t-bond rates has not grown significantly. First, it is not clear whether Donald Trump would keep his promise. The USD6tn plan faces financing difficulties. Second, although the deficit finance policy has good results in the short term, there’s a question as to its long-term effect. Third, the sharp rise of the USD index is not a good thing for the country’s employment and export. We expect that the Fed will not raise interest rates more than twice in 2017, the USD index will stay around 100 for a long time to come, and the pressure point of the index will be 105.

Figure 10 Nominal and effective rate of US Government bond

Source: Wind

Although the RMB now faces less pressure to devalue, it is still hard to improve its weak position against the USD. Despite economic and political uncertainties, the US economy appears in good shape. It is expected that the US will continue to normalize its monetary policy in 2017. As for the determination and comparison of the relative price, it’s unlikely that the RMB will see obvious appreciation against the USD, whether in terms of interest rate parity (short-term), purchasing power parity (mid-term), or comparison of mid- and long-term competitiveness (Balassa-Samuelson Effect). Furthermore, the RMB is weak against a basket of currencies. This is a result of the deepening market mechanism. It is one of the ways to mitigate the negative impact of the RMB’s weak position in comparison to the dollar. More importantly, it reflects the changes in the two economies.

III. 2017 Policy Outlook

1. Steadily Neutral Monetary Policy and Better Liquidity Management

The monetary policy will remain neutral since it must match the policy appeal to control financial risks and asset bubbles. Prevention and control of financial risks was placed at a more important position at the Central Economic Work Conference, according to which certain risk areas would be handled and asset bubbles kept under control. The monetary policies of 2017 will be in line with the policy requirements to deleverage, reduce bubbles, and prevent risks, so the policy framework will appear more neutral. This means that deleveraging and liquidity management in the financial sector deepend, and that liquidity of the banking sector might tighten.

It is important that the monetary policy stays neutral so as to adapt to changes in the currency supply pattern, adjust currency flow, keep the monetary policy transmission mechanisms and channels in good function, and maintain stable liquidity. Firstly, the monetary policy should stick to the bottom line of “deleveraging, de-bubbling, and risk prevention”; second, money supply should meet the endogenous demand of economic growth, so as to keep liquidity above the level necessary for economic growth; third, new liquidity management tools should be used more frequently. As the central bank’s key instruments in its open market operation, the raise of interest rate as well as liquidity recovery at the beginning of this year marks the change of interest rate policy from “loosely steady” to “tightly steady”. The raise of money price shows that the adjustment is forward-looking and mild rather than substantial, and that the central bank is taking the initiative in liquidity management. It is expected that the benchmark interest rate is projected to stay unchanged in 2017, and the reserve requirement might be lowered once.

2. Fiscal policy as a hedge and infrastructure as support

Fiscal policies should be proactive. Budget arrangement should meet the demands of facilitating the supply-side structural reform, easing corporate tax burden, and guarantee people’s basic living needs. The first task is to ease tax burden. The policy for pilot programs of replacing business tax with VAT should be improved to amplify the effect. Efforts should be made to develop new tax reduction policies. Unreasonable funds and charges should be cleared according to relevant standards, and administrative charges should be further standardized through cancellation and adjustment. The second task is to safeguard key areas. The expenditure structure should be improved to guarantee sufficient spending on key areas. Housing security should be provided, shantytowns should be transformed, and subsidies for renovation of dilapidated rural buildings should be allocated more precisely. The fight against air, water and soil pollution should be supported. The second round of pilot projects for the ecological preservation and restoration of mountains, water, forests, farmlands and lakes should start in good time. The third task is to handle debts. Existing government debts should be properly handled. More effort should be spent on replacing existing debt with local government bonds, which may be issued on a rotational basis.

Infrastructure remains a foundation for steady growth, which will continue to be led by the government and supported by infrastructure in 2017. The pro-growth task will gain more focus in 2017, and the fiscal policies will be the most fundamental policy tool in the second half of the year. According to the initial statistics of local government work reports, the total size of local government investment in 2017 is expected to be close to RMB 50tn, more than half of which will fund infrastructure projects.

3. Balance between RMB Exchange Rate and Foreign Exchange Reserve

From a more macro and open perspective, internal and external risks in China might intertwine to worsen circumstances. This requires the authorities to keep the RMB exchange rate and foreign exchange reserve in dynamic balance. As the Fed shifts its monetary policy framework from crisis to regular mode and the USD remains strong, the most immediate problem for China is the tough choice between foreign exchange reserve sufficiency and foreign exchange rate stability. From the perspective of the market game, consumption of foreign exchange reserve might threaten the stability of RMB exchange rate, which could lead to a vicious cycle between decreasing foreign exchange rate and reserve consumption. If the USD remains strong, it would be tough to reverse the expectation for RMB’s depreciation, and the cycle would be hard to break. Consequently, the final result may be that a relatively strong currency would be turned into phony money by negative market expectations. It is estimated that RMB will drop to 7.2 against the USD by the end of 2017.

A more flexible exchange rate might help maintain balance between the “safeguard” for foreign exchange reserve and the stability of foreign exchange rate. Financial risks are revealing on a daily basis in China. If the Fed continues to raise interest rates and abandon crisis policies, the divergence of monetary policy direction between China and the US might become clearer. Since US policy has obvious spillovers, the expectation for RMB depreciation might increase. To help the authorities win the battle for foreign exchange reserve sufficiency, it might be helpful to make the RMB exchange rate more flexible, allow the market to decide prices, keep close watch on and handle short-term capital flow, and develop effective risk control plans. If there is high expectation for a strong dollar and big foreign exchange consumption, it would be better to adopt a more flexible foreign exchange rate policy as early as possible.

4. Possible Changes of Real Estate Control Policies: Property Tax

Events in the past decade or so shows that real estate control policies have created a three to four year cycle for the housing market; however, such polices, with purchase restrictions as the key instrument, have proved inefficient and even futile in first-tier cities. The problem is that they only focus on controlling demand and do not take interaction between demand and supply into account.

If such polices continue to be implemented, the housing market will be exposed to risks due to the macro economy break out. Property tax has thus become a key policy option, and increasing land supply is now the fundamental tool to ease price bubbles in first-tier cities. In Chongqing and Shanghai, pilot property tax policies may not be able to tackle the problems in real estate transactions as well as those caused by over-investment, because these policies focus on newly purchased houses rather than existing ones. There are generally three categories of property tax: 1) transaction tax, 2) capital gains tax, and 3) holding tax. The first two are intended to reduce over-transaction and over-investment, and the latter two are meant to reduce excessive demand.

A more crucial task is to keep a balance between supply and demand. At the end of February 2017, the executive meeting of the municipal government of Beijing deliberated and passed the Plan for the Supply of State-owned Construction Land in Beijing, 2017. According to the Plan, the total land supply size this year would be 3,900 hectares, down 200 hectares from the year before. Of that amount, 610 hectares were residential land, a decrease of nearly 50%. The consequence of such a policy would be another surge in housing prices. Under the influence of real estate control policies, housing prices this year may decrease slightly from 2016. But in first-tier and some second-tier cities, the price may still stay at a high level.

5. The Economic Structural Reform is Yet to Deepen, and the Great Expectations are Placed on the 19th National Party Congress

For the market, the most anticipated change in 2017 policies is top-level planning for structural economic reform, namely the opening of the 19th National Party Congress. Since the 18th National Party Congress, it has become a core mission in China’s economy to deepen structural economic reform across the board; however, compared with reform targets from the Third Plenary Session of the 18th CPC Central Committee, it is clear that many areas still need attention, and that the market should play a role in resource allocation. As the reform has entered a more difficult phase, anticipated economic reforms include: firstly, to further specify the direction of market reform; secondly, to establish a pricing mechanism for important factors, such as interest rate, exchange rate, government bond yields, and land; thirdly, to advance reform in housing, land, household registration, pension system, education, public services, and other key areas; fourthly, to clearly identify the relationship between state sectors and private sectors, such as reforms of state-owned enterprises, public-private partnership (PPP), and diversified ownership.

IV. Investment Strategies: Retrospect and Outlook

1. Dollar and Gold Can Allocate Resources, Signaling the Idea that “Cash is King”

Regarding the allocation of internal and external assets in 2016, we emphasized that external assets, especially those without inherent risks, are valuable in the allocation process. We cannot expect large yields from investments in the dollar and gold - showing that that “cash is king” - but they can ensure that the assets are protected and grow at a reasonable pave. Earlier in the spring 2016 report, we suggested that investors take on dollar assets; in the case of gold, we observed the features of relative changes in gold price and dollar, leading to the conclusion that regular gold investment is better than any other investment. In the special report for overseas economy released in the fall of 2016, we have explored the price movements and investment strategies of gold and, while sticking with regular investment plans, stressed that the intensity of gold investments can be increased appropriately (which raised a lot questions in the market).

Regarding investments in gold and US dollar in 2017, we will reaffirm the same logic as in 2016. As dominant investment logic observes that cash is king, we shall consider about the opportunity cost of taking on positions when investing in dollar, and remain aware of the risk of adjusting USD equity assets. In 2017, investors can, as appropriate, increase investments in dollar equity, but they should be cautious about the intensity. In regards to gold, automatic investment plans are still preferred.

2. Investment in Real Estates in Third- and Fourth-tier cities Should Be Avoided

In the first pages of the summer 2016 report, we pointed to the risks of investing in the real estate market in 2016, stressing that the investment value of real estate in third- and fourth-tier cities could not last long. Although real estate in first- and second-tier cities might continue to witness a rise, we noted that real estate investment had made savings overstretched. Hence, we suggested that investors should not hold too many properties and cash out part of their holdings. For 2017, we will stick to our observation about the risks in real estate market as a whole, and suggest that investors not invest in third- and fourth-tier cities. The real estate in first- and second-tier cities is likely to grow more expensive, while the risks grow as well.

3. Opportunity for the Allocation of Rate Securities and High-grade Credit Bonds Gradually Emerge

Though the de-leveraging of bond markets is ongoing, the investment price of rate securities and high-grade credit bonds may be become increasingly clear. The spring 2016 report believed that bond allocation appeared to be fundamentally valuable. Later in the summer 2016 report, we pointed to the risks in bond markets, particularly those of credit bonds; however, we underestimated the intensity of de-leveraging in bond markets. As a result, in the fall 2016 report, we highlighted the risk increase in bond markets, those brought by market liquidity in particular. The de-leveraging of bond market began in August 2016, and the supervision of micro-prudential assessment (MPA) system and regulation of off-balance sheet business and future assets management have been strengthened. Therefore, we believe that the reduction of risks in bond markets in 2017 has reached a certain level and will continue in the future. However, due to the quick risk reduction in the earlier stage, the yields of 10-year government bonds rocketed from 2.66% to more than 3.49%, which brought about huge challenges in its price. It is predicted that there is still room for moderate increase in interest rates in the interbank market, and that the 10-year government bond yields may range between 3.1% and 3.6%.

For professional allocation institutions, government bonds and other rate securities have been exposed to allocation trends, as there is basically no further room to raise interest rates. Regarding credit bonds, high-grade bonds offer reasonable value for allocation with low-to-medium grade ones labeled with prudent investment, and low-grade ones suffering from ongoing exposure.

Figure 11 Yield movements of some rate securities

Source: wind

4. The IPO Process is Accelerating, and Investors Can Be Cautiously Upbeat about Stocks after the Adjustment of Market Valuations

For the equity investment in 2016, it was believed in China that the index of stocks might remain within a certain shock range of approximately 2800-3300 and witness a slight increase. Meanwhile, the market would take on notable structural characteristics. The demand-supported areas and those with strength in valuations would be priorities in allocation; examples for such areas are food and beverage, pharmaceuticals and medical equipment, infrastructure development, and undervalued blue-chip stocks, and those with high valuations shall be avoided, such as Internet and Internet finance. As suggestions for equity investments in 2016, we underestimated the elasticity of cyclical stocks.




Catering & tourism

Defense industry

Real estate

Public utilities

Electrical installations



Non-bank finance

Light manufacturing

Commerce & trade


Integrated industry

Electronic component


Farming, forestry, animal husbandry and fishery

Ferrous metal

Chemical industry

Non-ferrous metal

Extractive industry


Household appliances

Architecture & decoration

Building material

Food & beverage

文本框: Media Computer Transportation Catering & tourism Defense industry Real estate Public utilities Electrical installations Machinery Communication Non-bank finance Light manufacturing Commerce & trade Pharmaceuticals Integrated industry Electronic component Automobile Farming, forestry, animal husbandry and fishery Ferrous metal Chemical industry Non-ferrous metal Extractive industry Banking Household appliances Architecture & decoration Building material Food & beverage

Figure 12 Performance of stocks in various sectors in 2016

Source: wind

In 2017, the stock environment may see a slight improvement, and their index will remain within a certain shock range (predictably 3000-3500) and witness a slight increase. Firstly, the fundamentals of the Chinese economy will be relatively stable, and the overall debt levels of listed companies will fall slightly. Secondly, withdrawing money from the private placement of stocks has been discouraged; hence, though the IPO process is accelerating, stocks will not be systematically re-evaluated. Thirdly, strengthening micro-prudential supervision can regulate the market operations. Fourthly, the de-leveraging in real estate market and bond markets may lead to some financial return to the stock market and add to contribution margins. The market as a whole will remain structural: areas including military-civilian integration, infrastructure development, upgrading of consumption level, and pharmaceuticals and medical equipment may be more likely to embrace structural opportunities; areas including internet, new technologies, media, and computer may be divided internally after valuations are restructured, and there are also opportunities for individual stock options in these sectors.

5. Predictions for Major Economic Indicators

China’s economy will see certain downward movement in 2017. Nevertheless, because the 19th National Party Congress will be held soon, the general principle of seeking progress while keeping performance stable will play an important role in supporting economic development. The predictions for major economic indicators are presented below:



Predicted value


Growth of GDP



Increase of CPI



Increase of PPI



Broad money (M2)



Shanghai Composite Index



RMB Exchange Rate

7.2 (end of 2017)

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