ICC Research

An Outlook into the 2017 Chinese Economic Situation

Author:Yang Yuemin      Time:2017-02-14

In 2017, economic growth in China will maintain a stable rate, possibly at the same level as the previous year.According to the general guideline of seeking progress while maintaining stability, established during the Central Economic Work Conference at the end of 2016, anincreasing focus will be placed on the robustness of financial market, and the effect of supply-side structural reform.Foreseeably, the overseas market demand will keep declining, and an increasing stringency of financial regulation will dampen enthusiasm of capital market speculators, demand in the domestic market, however, is expected to expand. In relevant recommendations, development and reform policies in 2017 should include the following priorities: implementation of mixed economic reform, completion of the financial supervision system, acceleration of economic opening to the outside world, narrowing of regional economic imbalances, and improvement of income distribution.


I. The economic growth in 2017 will maintain a stable level

      (1) Consumption will continue to grow in 2017 as it did in 2016.

As per leading indicators in the consumption field, in September 2016, the reported unemployment rate in 31 large cities and towns dropped below 5% for the first time since June 2013, indicating a better-than-expected employment situation. In 2016, the growth rate of per-capita disposable income generally stopped falling, and the consumer confidence index continued to rise during the second half of 2016. In addition, consumption guideline documents issued by the central government and relevant ministries and commissions (such as Guiding Opinions about Reinforcing Financial Support in New Consumption Fields and Notice about Printing and Distribution Actions for Promoting Consumption and Driving Higher Level Transformation) have been helping promote domestic demand. The application of Internet Plus and the new urbanization trend will also greatly contribute to consumption demand and drive consumption upgrades. From the perspective of long-term momentum, although the rate of saving, which was as high as 47.9% in 2015, has continued to drop in recent years, it is still far higher than the world average level of 26.2%, thus allowingmuch room for expanding domestic consumption. 2017 will witness continual consumption growth, and a healthy growth pattern is anticipated.

(2) In 2017, two investment driving factors will follow different trends, and the real economy is expected to become more stable.

In 2017, infrastructure construction will serve as the basis for investment promotion by governments on different levels. At the end of 2016, the State Council and relevant ministries and commissions issued policy documents concerning asset securitization and completion of the property protection system for public-private partnership (PPP) projects in the infrastructure field, providing strong support for infrastructure investment from the perspectives of investment, financing, and system construction. As a leading indicator for infrastructure construction, production of excavators experienced a rapid YoY increase during the second half of 2016, and rose above 60% in October. In 2017, with further implementation of the PPP pattern, investments in infrastructure are expected to maintain a high level.

The tightening of real estate policies in 2017 will have more implications for development volume than for price, and will exert certain influences on both upstream and downstream industries such as iron and steel, construction materials, and home furnishing, but with a limited impact due to the following facts. First, the risk prevention objectives of the real estate industry are not very closely related to tier-3 or -4 cities. Second, as the plummeting of property prices would cause systematic risks to banks, the policy-guided regulations in 2017 will mainly aim at suppressing speculative demand for real estate, with price fluctuations being well controlled.

 During the first half of 2017, the stable growth of the manufacturing industry is attributable to higher profitability of entity enterprises in 2016 and marginal improvement of investments. In the second half of 2016, as the structural reforms of the supply side achieved initial success, the investment expectation of the manufacturing industry continued to improve. Both the official manufacturing Purchase Managers’ Index (PMI) and the civil PMI stayed above the entrepreneurs’ confidence threshold for five consecutive months. The Industrial Product Price Index experienced positive growth for three consecutive months. Large and medium enterprise profit continued to rebound, and stock of both raw materials and manufactured products rose again slightly. In the first half of 2017, such rebound trends in entity enterprises and basic industries will hopefully grow stronger. Regarding specific sectors: information services, high-end manufacturing, and pharmaceutical manufacturing will still be the main drivers for investment. In contrast, automobile manufacturing will no longer provide strong momentum for investments after the tax exemption policy expires at the end of 2016.

(3) Exports in 2017 will remain weak, though with a less significant decrease.

The second half of 2016 saw increases in the China Containerized Freight Index; the amount of cargo throughput in main coastal ports;the number of purchasers attending the China Import and Export Fair; and export turnover. The PMI New Export Order Index stayed above the entrepreneurs’ confidence threshold for four months. A series of export leading indicators predicts that the harsh export situation will be alleviated in 2017. Although OECD composite leading indicator, the macroeconomic conditions in G7 countries, also predicts a rebound, Chinese exports going to developed countries will face a hard time. The new administration of the U.S. government has stated a plan to impose 45% tariffon Chinese import, and the European Union is planning to reach a free trade agreement with Japan as the alternative to the abortive TPP. Fifteen years after the admission of China into the WTO, the United States,the EU, and Japan have all declared an intention to deny the market and economic position of China. Since these countries account for over 40% of China's total exporting, their hostile attitude may set a general tone for weaker exports from China in the next year. In 2016, in spite of the general downturn, Chinese exports to 28 countries along The Belt and Road zone achieved a positive growth. Such exports will continue to be highlights in China’s foreign trade in 2017.

(4) Inflation may go up in early 2017, but will possibly experience a less significant annual increase.

As far as the Consumer Price Index (CPI) is concerned, a high tail-raising factor is expected because the Spring Festival is in January this year. Consumption demand during the Spring Festival may boost the CPI to a high level in the beginning of the year. As for the Producer Price Index (PPI), coal, iron, and steel will fall short of demand due to de-capacity, winter heating, and infrastructure construction. As a consequence, the price of industrial raw materials and bulk commodities may rise. In early 2017, the CPI and PPI are very likely to stay at a high level. A price increase in upstream links of the PPI chain may result in higher cost pressures on downstream enterprises and repeated ‘de-capacity’ cycles in midstream enterprises, which requires further vigilance. Furthermore, periodic inflation of prices may negatively impact the lives of low-income populations. Measures should also be taken to curbthe potential trend of stagflation. As for the general trend throughout the year, there will be significant uncertainties in the PPI due to the impact of further implemented structural reforms and fluctuations of international bulk commodities. Considering that the liquidity margin narrowed in late 2016, monetary policies in 2017 will remain prudent and relatively neutral (as they were during the second half of 2016). Chances are that the CPI increase rate will be lesser than that of 2016.


II. Macro-policy pivoting and capital market trends

(1) The liquidity inflection point is coming in 2017. The neutral nature of monetary policies will be maintained, and fiscal policies will serve as the engine for spurring economic growth.

With credit growth in recent years, capital markets such as stocks, bonds, and housing haveall experienced bubbles bursts. The substantial depreciation of Renminbi(RMB) during the second half of 2016 not only exerts a huge downward pressure on the foreign exchange reserve through financial accounts, but also poses a challenge to a stable domestic financial system. Under this background, risk prevention and exchange rate stabilization were given top priority during the CPC Central Committee Political Bureau Conference on October 28 and Central Economic Work Conference on December 16. A decrease of the deposit-reserve ratio or interest rate seems to be unlikely in 2017, and it would bedifficult for M2 to regain a high growth rate of 13–14%. The inter-bank offered rate will continue to rise, and the trend of narrowing bank and liquidity margins will persist.

It was clarified during the Central Economic Work Conference that fiscal policies in 2017 should be more active and effective so as to better accomplish policy targets including advancing reforms, creating development momentum, and supporting livelihood programs. At the end of 2016, the State Council issued the Scheme for Helping 100 Million Non-resident People Obtain Permanent Urban Residence. The new urbanization process is expected to be further advanced in 2017. Fiscal policies will be directed towards expanding effective demand, achieving a balanced regional distribution of quality social resources, and driving local industrial transformations. The recently launched PPP asset securitization program will further improve fiscal leverage.Mixed ownership reform was defined in this conference as an important starting point for reforming state-owned enterprises (SOEs). In 2017, synergies between the ‘Cost Reduction’ and the mixed ownership reform of SOEs will be pursued to fully release development dynamics of enterprises, improve the productivity of industrial sectors, and realize high-end industrial development.

(2) The possibility of drastic fluctuations in the capital market is remote due to underlying policies in place for exchange rate stabilization and risk prevention.

In the foreign exchange market, as the mechanism-driving marketing of the RMB exchange rate continues to evolve, the impact of the US currency trend on this rate should not be ignored. As far as the 2017 general trend is concerned, the US Federal Reserve has announced a plan to raise the interest rate three times within this year, which will possibly lead to a stronger US dollar. However, the fiscal expansion policy adopted by the Trump administration may result in the constant escalation of the US deficit, and market expectations of the effects of such a policy tend to cause great uncertainties in US dollar trends. The appreciation of US dollars lacks a solid long-term foundation. In the domestic market, as the next-stage growth target have given way to the goal of systemic stability, a further decrease in the RMB exchange rateis likely to be seen in 2017. However, in the long run, there is still a sound basis for the stabilization of the Chinese real economy, and potential for appreciation of the RMB also exists.

The general conception behind curbing real estate bubbles will remain unchanged in 2017. Restrictions on purchase and credit will lead to a drastic drop in this market in terms of transaction volume compared to 2016. However, considering that the shrinkage of the real estate industry will take a toll on the general economy and increase financial system risks, the regulation policies will be probably milder than those at the end of last year. In the bond market, a panic drop occurred at the end of 2016:the yield of treasury bonds rose sharply while treasury bond futures declined by the limit. In 2017, monetary policies will be tightened with reinforced risk-prevention regulation. The inflation expectation will continue to drive middle- and long-end yields, exerting pressure on the bond market. In the stock market, both theShanghai A-share Index and P/E ratio have been improving. Non-financial listed companies have shown signs of bottoming out in terms of profitability, return on assets, and capital expenditures. Investor expectations are rising. In the first half of 2017, the stock market will probably remain steady with certain growth, although major uncertainties are anticipated throughout the year due to economic fundamentals, market liquidity, financial regulation, and trends in the US stock market. The likelihood of a drastic rise is small. In the bulk commodity market, the end of 2016 saw intense investments and a rapid increase in the prices of minerals, energies, oils, steel, and iron. In 2017, the steady progress of supply-side structural reforms in China and large infrastructure construction plans adopted by many countries will benefit bulk commodities. The price of industrial raw materials particularly will be generally maintained at a high level.


III. Policy recommendations

In 2017, structural reforms will enter an in-depth stage requiring attention to deep structural contradictions. The main objectives of such reforms include prevention and control of systematic risks and development of new dynamics. On one hand, systematic risks will be prevented by reinforcing financial foreign exchange regulation and alleviating market panic expectations. On the other hand, mixed ownership reform will be advanced to achieve wider and deeper economic opening; better leverage fiscal tools; allocate social resources in different regions, departments, and enterprise entities in a more balanced fashion; and create new growth momentums.

(1) Accelerated implementations and breakthroughs of mixed ownership reformsshould be instructed by market logic.

Since the publication of the top-level 1+N reform solution for state-owned enterprises,certain progress has been made by these enterprises in the past two years in terms of mergers and reorganization, de-capacity, and property-right reform. Hopefully, 2017 will mark an accelerated implementation of mixed ownership reform. For main sectors that have been clearly included in the reform range such as power, petroleum, and natural gas, the governance system will be further established with strengthened incentives to concentrate on main businesses and achieve higher efficiency. In the competitive market, state-owned enterprises are gradually shifting away from the pattern of majority shareholding. Relevant laws and regulations are beginning to clarify equity division between different ownership subjects as well as the division of rights and liabilities in decision-making mechanisms. These measures are intended to strengthen the confidence foundation of private capital and to regulate operational procedures for national asset prevention loss. Guidelines on different equity participation forms, such as funding or listing modes, will also be implemented to provide a concrete legal basis for private capital to take part in the mixed reform of state-owned enterprises. With regard to management systems, organizational and incentive innovations can be sought. Examples include a reasonable combination of efficient corporate management and party-building tasks;the inclusion of innovation ability, market competitiveness, and service and product quality as important appraisal indexes; and the distribution of shareholding rights to core technical personnel, middle and senior management, and business backbones in technical and scientific state-owned enterprises with mixed ownership. New models such as converting debts into shares and PPP can also be considered to give impetus to the above-mentioned reform. Private capital will be encouraged to participate in structural reform tasks on the supply side, including de-capacity, deleveraging, and gap-filling. It will contribute to improving corporate balance sheet as well as the investment, operation, and management capabilities of state-owned enterprises.

(2) A policy portfolio that fits the need of financial risk prevention should be developed as soon as possible.

In the latest Central Economic Work Conference, a higher priority was assigned to the prevention of financial risks. More intense efforts should be made in the current stage to fight illegal behaviors in various capital markets, promote the construction of the social credit system, eliminate regulatory gaps and arbitrage, reduce regulation costs, and improve regulation effectiveness. In the domestic market, big data will be adopted to complete the construction of the credit reporting system and information disclosure mechanism. The system will contain both institutionalized incentives for faithful behaviors and punishments for faithless ones. A risk evaluation system should be built to identify and monitor system risks. For listed companies facing bankruptcy or with pending litigation, strict delisting procedures should be adopted. All unregulated or fraudulent Internet and financial projects should be banned. To address financial resource transfers in the disguise of foreign investment, the People’s Bank of China and relevant regulatory authorities should establish better cooperation with overseas Chinese financial institutions, embassies, and relevant agencies in the fields of cross-border credit system construction, supervision, and monitoring. Overseas investments should be investigated during and after investment events to check for authenticity and legal compliance. A regular inspection and investigation system should be in place to serve such purposes. Considering that fluctuations of the RMB exchange rate pose a major challenge to a stable financial system in China, close attention should be paid to the international economic and financial situation in 2017, especially due to policy changes to be made by Trump’s administration. Offshore regulation will continue to serve as an effective tool for cracking down on short selling behaviors; in the meanwhile, normal RMB investment demands should be identified to prevent drastic fallback during the RMB internationalization process. Policies concerning RMB-based overseas investments should be formulated soon. The reference weight of non-USD currencies in the currency basket can be further increased if necessary to weaken the impact of the USD and any changing policies of the US Federal Reserve regarding the RMB exchange rate. Finally, expectation management should be further reinforced to correct market misunderstandings and panics in a timely fashion and to suppress speculative behaviors.

(3) Advancing a wider and deeper economic opening to achieve stronger growth momentum

The construction of The Belt and Road zone and international production capacity cooperation will greatly improve China’s export environment. To achieve technological and industrial upgrades in the shrunken global industrial chain, it is urgent to focus on key fields and accelerate the development of new growth channels with reinforced regulations and supporting mechanisms. Among the possible key fields are high-end manufacturing, communication technology, and new energy. Technological cooperation mechanisms and incubation platforms can be set up to accelerate the conversion and application of scientific and technical achievements. Depending on the specific industrial structures and local demand in different countries, the optimization of industrial chain resources should be promoted while avoiding excessive local production capacity. Moreover, a sound foreign investment system should be built and completed, and better cross-border cooperation with overseas Chinese institutions should be established for credit system tracking, assurance, and regular evaluation of major projects. Economic, financial, managerial, and legal experts can be dispatched to quasi-governmental organizations and Chinese embassies and consulates abroad to greatly promote the construction of The Belt and Roadzone as well as the implementation and assurance of international production capacity cooperation programs. The policies concerning The Belt and Road will be used to guide opening tasks in coastal and border areas to advance regional coordination across the nation and achieve more balanced regional development. The business environment for foreign capital will be further optimized. Tax leverage and favorable credit policies will be used to guide foreign investments. Integration with other directional policies such as those used for systematical poverty relief, PPP, and de-capacity in Northeast China will also be pursued with the intention of  helping enterprises overcome financial, technical, and managerial obstacles to industrial upgrades and local development.

(4) Making active efforts to promote new urbanization and the balanced distribution of quality social services.

Regional development policies tailed to local conditions should be formulated in the current stage. Innovative ideas and concepts should also be developed to achieve development coordinated by the urban and rural alike. The first key point for urbanization lies in an assurance system that can gradually expand to meet effective demand. The construction of the residence permit system should be accelerated, and basic education and medical rights of permanent residents should be guaranteed. The settlement of urban floating populations should be sped up. The second key point for urbanization lies in the innovative growth pattern that can drive and optimize effective supply. For example, aPPP model can be adopted to expedite the merger of new urbanization elements, Internet Plus, new economic driving factors such as innovations and ventures, and relevant resources. In the meanwhile, more favorable policies, especially those concerning taxation and the establishment of financial institutions, can be adopted in middle and west China to make better use of foreign capital and attract private investments. Large enterprises and financial institutions will be encouraged to support less-developed areas by providing necessary resources and talents. Education and medical institutions from developed countries can also be attracted to China, opening branches or launching joint projects. These activities will cultivate new growth momentum, optimize local industrial layouts, improve the quality and efficiency of local public services, and achieve a healthy and sustainable development of the local economy.

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