March 29, 2016

Comments on 2016 China "Two Sessions" Policy Direction
During the annual National People's Congress (NPC) meeting on 5 March 2016, Chinese Premier Li Ke Qiang announced that China's GDP is expected to grow within the target rate of 6.5% to 7.0% during the period of the 13th Five Year Plan (2016 to 2020). In this article, we will discuss the messages outlined in the "Two Sessions" meeting and provide our view on China's economic outlook for the coming years.

by iFAST Research

 Comments on 2016 China “Two Sessions” Policy Direction

During the annual National People’s Congress meeting on 5 March 2016, Premier Li Ke Qiang has announced that the China’s GDP will be growing at a target rate of 6.5% to7.0% during the period of its 13th Five-Year Plan (2016 to 2020). In this article, we will discuss on the messages outlined in the “Two Sessions” meeting and provide our view on China’s economic outlook for the coming years.

The 12th Annual National People’s Congress meeting officially kick-start on 5 March 2016, with Premier Li Ke Qiang taking the lead in delivering the government’s annual work report and the country’s social and economic development blueprints for 2016 and the 2016-2020 period. He also presented on the central and local draft budgets for 2016.

Setting GDP growth target at 6.5% to 7.0% promoting domestic consumption

The first point in this meeting is the main target of the 13th Five-Year Plan, from 2016 through 2020. During the 4th session of the meeting, Premier Li Ke Qiang announced that from2016 to 2020, China economy is expected to grow within the target range of 6.5% to 7.0%. The nation’s economic policy will remain focused on structural reforms and the improvement of social wellbeing of its people. The government shall work to maintain a medium-high rate of growth while at the same time, propel the development of industries toward the medium-high end. By 2020, China’s aggregate economic output is expected to exceed 90 trillion yuan, with the advanced manufacturing, modern services and strategic emerging industries as a proportion of GDP projected to rise significantly. The nation’s per capita labour productivity is also expected to rise from RMB 87,000 yuan to RMB 120,000.

These targets are relatively ambitious.  However, the nation only slightly missed the growth target back in 1998 and 2015 based on the nation’s historical track record since 1996. As the nation revised down its target to a modest level of 6.5%, China might be able to achieve or even exceed the targets based on its strong track record.

Graph 1: China: GDP Growth vs. Target


The main focus of the 13th Five-Year Plan is on structural reforms and improving social wellbeing of its people. The official forecasts tertiary sector would contribute more to the economy from a GDP weight of 50.5% in 2015 to expand further to 56% by 2020. This implies tertiary sector in the upcoming 5 years would have to grow in a compound annual growth rate of 8.7%. While primary and secondary sectors growth rate would continue to diminish to 4%. China has a population of 1.3 billion people. With the increase in the consumption permeability rate, the potential for growth in domestic demand is very high.  China hopes to boost job creation, increase minimum wages as well as strengthening social safety network in order to achieve the goal of inducing people to save less and consume more.

Graph 2: Contribution of Private Spending and Investment to China GDP Growth


Increase 2016 Fiscal Deficit Budget to 3% to Support economic growth

Looking back to 2015, the government specifically mentioned on the difficulties that the nation faced in the progress of developing its economy. With the challenging international environment, China’s exports fell short of its expected target, which is a rare occurrence for China.

Looking forward to 2016, China’s fiscal deficit budget was increased to 3%, equivalent to RMB 2.18 trillion, an increase of RMB 560 billion compared to last year. The government believes that a reasonable increment of the fiscal deficit will be able to support the structural transformation process of the economy. This year’s budget includes expenses for government’s infrastructure spending, resettlement of laid off employees from enterprises with overcapacity issues and tax deductions arising from the replacement of business tax with a value-added tax (VAT).

Graph 3: GDP Growth vs. Government’s Fiscal Deficit Budget


Corporates benefit from the replacement of business tax with value-added tax (VAT)

Aside from the continued support on the central infrastructure projects (budgeted expenditure of around RMB 500 billion), the policy will increase its expenditure for supporting the poor and the reallocation of laid off employees from overcapacity industries. RMB 100 billion in rewards and subsidies will be provided to resettle employees laid off from enterprises that face overcapacity issues, lessening the negative impacts of the economic transition process on these overcapacity industries and sectors in the “old economy”.

Another major point that the government will emphasise on this year is the implementation of VAT. The main cause of the increase in fiscal deficit is due to tax cut. The government hopes to further reduce the burden of corporate and help to stabilize economic growth. This year, there are 3 main measures that will be implemented:

1) Full implementation of VAT. Starting from 1 May 2016, the scope of work to pilot this measure will be extended to cover construction, real estate, financials and consumer service sectors. All enterprises’ new immovable property will also be included in this measure.

2) Government-managed funds that were set up without authorization will be eliminated. Collection of contributions to certain government-managed funds will be suspended and more enterprises will be exempted from the contributions to water conservancy construction funds and other government-managed funds.

3) Exemptions from 18 administrative charges, which currently applicable only to small and micro businesses, will be expanded to include all enterprises and individuals.

The implementation of VAT is basically a cut in tax collections. While the standard tax rate remains to be at 17%, the tax base is expected to contract given that all immovable properties are applicable for tax exemptions. The reduction of tax collections by the government has been reflected in this year’s fiscal deficit estimation. These measures are likely to cut government’s tax collections by more than RMB 500 billion this year. With the moderation of economic growth, tax reductions are positive news for enterprises; the end-results ultimate depends on the effectiveness in implementing these measures.

Continue to implement proactive fiscal policy and prudent monetary policy

This year, the government will continue to implement proactive fiscal policy and prudent monetary policy to ensure that the economy grows within a reasonable range. In line with consensus expectation, People’s Bank of China still have room to cut its benchmark interest rate. However, local real estate prices have stopped falling, and rebounded. In fact, some of the property prices in Tier 1 and 2 cities have recorded double digit growths on a year-on-year basis. As such, we believe that the central bank will take this factor (property price fluctuation) into consideration when they decide on whether to cut the benchmark interest rate further. This indicates that if the central bank opts to cut the interest rate further this year, the magnitude might not be as large as compared to last year. However, one thing to note is that the government, mentioned in the report, that they can also utilize other measures such as targeted and timely adjustments, along with the usage of financial, industry, investment and pricing policy tools to boost the nation’s economic growth. As the conventional interest cut measures might not be the most effective way, investors could expect to see various implementation of supportive policies that are more industry specific going forward.

Figure 4: China: Benchmark Rate


Figure 5: Real estate price


2016 Focus on Supply side Reform

In 2016, Premier Li Ke Qiang has been repeatedly pushing for structural reforms, stabilising growth rate, striking balance on structural adjustments and ensuring the economy growing at a reasonable range. The government will gradually address the overcapacity issues in Industries such as steel, iron, cement, aluminium. In 2016, the focus will be on steel and coal, with the government expecting to utilise measures such as mergers, debt restructuring and bankruptcy liquidations to eliminate backward production capacity. To address the overcapacity issues in the steel and coal industries, Ministry of Human Resources and Social Security has suggested to lay off 1.8 million workers in these industries (1.3 million from coal industry and 0.5 million from steel industry). The government will be allocating 100 million yuan to relocate these laid off workers.

Although the concept of SOE reforms has been mentioned several times, further release of details regarding this reform is likely to be positive for the stock market. In 2015, there have been 12 SOEs that underwent restructuring process, reducing the number of SOEs from 112 to 106. Some restructured SOEs include China Minmetals Corporation, China Ocean Shipping Company, China Merchants Group and Sinotrans. In the coming years, the focus of restructuring process will be on industries that have overcapacity issues such as steel, coal, cement, aluminium, glass, metals, shipping, etc.

Focus on Renewable Energy projects and clean projects to protect environment

At this juncture, coal remains the main source of energy in China. By 2050, the government expects coal to still be a significant source of energy, making up more than 50% of the nation’s total energy sources. The usage of powder coal and untreated coal is the major contributor to the occurrence of haze in the cities of Eastern China. Carbon emission has a direct relationship with the development of a nation. China remains to be a developing country; and the usage of energy resources remains great. However, there is room for adjustment for the structure of energy industries.

Going forward, China needs to lean toward “green”, low carbon and recycling development to ensure the sustainable growth of the economy. In the development of renewable energy, China’s renewable energy capacity constitutes 24% to 25% of global capacity, with the increased production in recent years making up 37% to 42% of the increment of global production.

Full implementation of Two Child Policy

The “Two Child” policy, introduced during the fifth plenary session of the 18th Communist Party of China’s (CPC) Central Committee, was the strategy implemented for the long term development of China’s population growth. 13 provinces, such as Guangdong, Shanghai and Hubei, have completed the amendment of their Provincial Population and Family Planning Regulations, with the other provinces expected to finish the regulatory amendment by end-March. The government estimated that there are approximately 90 million couples that are eligible for the “Two Child” policy. With the full implementation of this policy, it is expected that there will be an increase in population growth, especially the growth of new-borns, for the following years. By 2050, working-age population is expected to increase by 30 million, with the old age population decreasing as a proportion of overall population. This will allow China to form a more balanced population structure. The government is currently analysing on related family support measures that will support the “Two Child” policy.

Another positive news to the sectors is the relaxation restriction on  Hong Kong – China joint venture  Chinese healthcare related  projects. There are two types of Hong Kong-established medical facilities. The first one is a joint-venture medical institution, which allows qualified doctors from Hong Kong to practice medicine in China for a short period of term upon registration. Shanghai and other provinces along the coast line will be set as the base for more joint venture partnerships between China and Hong Kong, including some large-scale joint ventures of medical institution projects.

The second type is a wholly-owned medical institution in China by Hong Kong. The set-up of these institutions need to meet the requirement of similar domestically set-up medical institution. At the same time, these kinds of institutes also need to seek approval from the regulators and the government is planning to relax the approval rights to  provincial authorities.

Improve social wellbeing of people

  • During 13th Five year Plan period, economy is expected to grow 6.5% -7% to a size over RMB 900 Trillion.
  • Before 2020, increase proportion of the service sector as a percentage of GDP from 50.5% to 56%.

Increase minimum wages

  • Relaxation of hukou system, promoting the migration of people from rural to urban area. 100 million people from rural area are expected to move to city areas in the following 5 years. By 2020, urbanisation rate is expected to reach 60%.
  • “Internet Plus” to promote creation of new village infrastructure.
  • Develop countryside tourism to increase the income level of people in rural area.

Strengthen social safety net

  • Expand the coverage of social safety net.
  • Improve social security, health insurance plans and private pension funds.

State-owned Enterprises (SOE) reforms

  • Ensure the steady cut of overcapacity in industries such as steel, cement and aluminium industries. The focus in 2016 will be on steel, coal and other industries that face overcapacity issues. Measures such as mergers, debt restructuring and bankruptcy liquidations will be utilised to eliminate backward production capacity.
  • Rewards and subsidies of 100 million yuan to be used in 2016 and 2017 for resettlement of laid off employees in overcapacity enterprises.

Tax Reform

  • Full implementation of VAT in 2016, further lessen tax burden for enterprises. This will be extended to include construction, real estate, financial and consumer service industries. The total tax deduction is expected to be 500 billion yuan.
  • Exemptions from 18 administrative charges, which currently only application to small and micro businesses, will be expanded to include all enterprises and individuals.

Financial Reform

  • Develop the idea of Internet financing.
  • Implement registration-based IPO system for stock market.
  • To promote financials and intuitions mixed ownership.
  • To implement full coverage of risk control and monitoring.


Green Development

  • Promote the usage of clean coal
  • Vow to put a peak on carbon dioxide emissions by 2030
  • Expand renewable energy projects

Healthy China

  • Fully implement “Two Child” policy, expect working-age population to increase by 30 million people by 2050.
  • For joint-venture medical institutions (between Hong Kong and China), qualified doctors from Hong Kong can register to practice medicine in China for a short period of time.
  • For wholly Hong-Kong owned medical institutions, the approval authority is delegated to the provincial authorities.


Investment Implication:          
We are not surprise with the government’s slight downward adjustment of the nation’s GDP growth target as well as the change of the 13th Five-Year Plan’s economic growth target from a single number to a target range. The lower GDP growth target was also reflects the weakening external demand.

In fact, downward adjustment of growth target and the government’s role in the National People’s Congress meeting led us to believe that China will continue to stimulate domestic demand and push for the transition of its economy. From the downward adjustment of growth target and the government’s perspective during the meeting, we believe that China will continue to boost domestic demand and push for the economic transitioning process of the nation. We maintain our outlook for China remains positive.

Furthermore, the fear on RMB depreciation had eased. Under rapid Chinese Tier 1 Cities Property Prices surge, the room for PBOC to cut benchmark interest rate is narrowed. We expect even there are cuts, the magnitude of cuts would not be as aggressive as 2015. As such, depreciation pressure on Yuan-to-USD is lower as rate cut expectation is eased.  On the other hand, the latest US Fed meeting had also lowered the rate target this year from 1.375% to 0.875%. The number of rate hike was also revised down to 2 accordingly in which resulted in a weaker USD.  In the light of stronger RMB to USD trend, overseas investors may regain their interest on the Chinese market favouring riskier asset performance. As of 18 March 2016, the estimated PE  of China H ‘s are now trading at 9.1X and 8.0X for 2016 and 2017 respectively, indicating a large discount when compared to our Fair PE of 12X. as the risk appetite started to improve, investors can take an eye out of the China H market.

As mentioned in the previous article “Rigorous Stock Picking Would Be The Key For China H Market 2016”, the transition of the Chinese economy has resulted in diverged performance among sectors. As such, investors who wish to invest in China equity markets through unit trusts should take a close look at the sector allocation of these funds. Besides the four major investment themes that have mentioned, the Chinese consumption theme may also presents good investment potentials for the upcoming five years. Investors can consider the best Year performing year-to-date Chinese equity funds and some Asia and Chinese consumption related funds for your reference. 

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