Lu Ting │ The improvement of the economic situation depends on the introduction and implementation o

Lu Ting is the Chief Economist for China at Nomura Securities. He previously served as Chief Economist and Managing Director at Huatai Securities, Chief Economist and Managing Director for Greater China at Bank of America Merrill Lynch, and a consultant for the East Asia Department of the International Finance Corporation and the Research Department of the World Bank. In 2010 and 2011, he was named the most accurate forecaster of Chinese economics by Bloomberg News. Lu also serves as Vice Chairman of the Hong Kong Chinese Financial Association and Vice Chairman of the Beijing Chunhui Bo'ai Children's Aid Foundation. He holds a Ph.D. in Economics from the University of California, Berkeley, and Master's and Bachelor's degrees in Economics from Peking University. He is a Chartered Financial Analyst (CFA).

The following is the full text of Dr. Lu Ting's speech:

I'll briefly share my views on the Chinese economy this year. First, I'll state a few key assessments:

First, China's economy still faces significant downward pressure this year.

Second, traditional policy space has indeed shrunk.

Third, the stabilization and improvement of the economic situation this year depends on the introduction and implementation of non-traditional policies.

First, the Chinese economy faces downward pressure. Why do I say that the Chinese economy is facing significant downward pressure this year? I believe the pressure mainly comes from three aspects:

One source of pressure is undoubtedly the US-China trade war. In fact, the trade conflict between China and the US last year actually boosted China's exports. Due to a significant rush to export, coupled with the relatively strong economic performance of core developed economies last year, China's export growth rate was nearly 10%. However, in the first two months of this year, it has already fallen to around -5%. If this trend continues, the decline in exports this year will have a significant impact on the Chinese economy. The overspending effect of last year's rush to export has already become apparent in recent months and may continue for some time, which will have a more pronounced negative impact on exports and economic growth in the first half of the year. Exports have a significant impact on the Chinese economy; calculated by value added, exports account for about 13% of GDP.

The second source of pressure comes from the government's previous round of policy stimulus. The 2015-2016 stimulus left some lingering effects on the Chinese economy. We will focus on two aspects: First, the real estate sector. The previous economic recovery relied heavily on stimulating the real estate market, especially through the central bank's Pledged Supplementary Lending (PSL) program in third- and fourth-tier cities. We have seen a significant decline in new home sales in recent quarters, with the year-on-year growth rate of new home sales area in the first two months of this year further dropping to around -4%, entering a contractionary phase. The impact of real estate on the Chinese economy is self-evident; in fact, if we add up its direct and indirect impacts, its share in GDP may be as high as 25%. Second, the automotive sector. We all know that automobile production and sales have declined significantly since the second half of last year. Stimulated by the reduction in vehicle purchase tax in 2016-17, automobile production and sales experienced a small and short-lived boom, but this came at the cost of overdrawing future demand. Starting in the second half of 2018, the year-on-year growth rate of automobile sales began to decline rapidly, reaching only about -10% in January and February of this year. The downward trend in automobile production was even more pronounced, with a year-on-year growth rate of only about -17% in January and February.

There are other factors that, while representing a smaller proportion of GDP, deserve our attention due to their significant fluctuations in growth rates or their connection to industrial restructuring and upgrading. For example, after experiencing high growth driven by product replacement cycles over the past two years, the sales and production of China's construction machinery are currently facing considerable downward pressure due to the end of the replacement cycle and last year's high base. The mobile phone industry, which is crucial for the upgrading of China's manufacturing sector, is also not optimistic; production and sales have been contracting in recent years, with mobile phone shipments in January and February this year showing a year-on-year growth rate of approximately -15%.

Secondly, the space for traditional policies. Just how much space is there for traditional policies? Qiao Hong just mentioned her feelings about overseas roadshows over the past few years, and I have very similar feelings.

When we went on global roadshows in 2008-09, we told foreign investors that China had a lot of policy space because at that time, foreign exchange reserves were 40% of GDP, the broad trade surplus and current account surplus were 10% of GDP, the rate of return on investment was relatively high, and foreign debt was almost zero.

Do these conditions still hold true today? These conditions have changed considerably over the past decade, particularly in terms of foreign exchange reserves and trade surplus. my country's foreign exchange reserves are now just over 20% of GDP, a decrease of $900 billion from previous highs. When I first left Merrill Lynch, overseas dollar bond investments by Chinese companies were still a small business for major banks, with outstanding bonds amounting to only $240 billion at the end of 2014. Today, that figure is close to $800 billion. China's capital market has seen a significant acceleration in opening up to foreign investment in recent years, and overseas investors' purchases of Chinese bonds (mainly government and policy bank bonds) have now exceeded $250 billion. Combining these two dimensions alone, China's external debt has increased by nearly $800 billion in the past few years.

On the other hand, we must consider trade and current account surpluses. my country's current account surplus is shrinking rapidly, from 10% in a broad sense 10 years ago to around 0.4% in 2018. This year, we may see the first current account deficit in decades. In fact, when a country's foreign exchange reserves decline, foreign debt rises, trade surplus shrinks sharply, investment returns decline significantly, and the government hopes to keep the RMB generally stable, the traditional space for leveraging to drive China's economic recovery has greatly diminished. We are not saying there is no space at all, but compared to 2008-09, 2012-13, and 2015-16, the space has clearly shrunk.

During the policy easing cycle of 2015-16, we essentially achieved economic recovery through increased leverage, but the method of leveraging differed from previous rounds. In 2015-16, we witnessed the rapid expansion of P2P lending and the rapid development of the domestic high-yield bond market. On the other hand, some new financing methods also developed rapidly, such as equity pledges and overseas dollar bonds issued by Chinese companies. The expansion of these emerging credit channels effectively drove the economic recovery in 2015-16.

These credit channels have passed their era of high growth. In fact, some channels have not only failed to grow in recent years but have actually contracted, such as P2P lending and equity-pledged financing. The scale of maturing overseas dollar bonds issued by Chinese companies will also increase significantly in the next few years, meaning that the room for net financing growth in overseas dollar bonds is not very large. Just over three weeks ago, a provincial investment platform company defaulted on its first interest payment on dollar bonds issued overseas.

Finally, unconventional policies. Having discussed the constraints of traditional policies, let's look at where there is hope for economic recovery. I believe that unconventional policies, especially structural reforms, will offer more highlights this year, and this is where the hope for China's economic recovery lies. Since the end of last year, we have seen more policies benefiting private enterprises and larger-scale tax cuts. Behind these reform measures, I believe it is crucial for the government to re-evaluate the market and enhance its role in resource allocation. This is not only related to this round of economic recovery but also to China's long-term economic prosperity.

Specifically, on the one hand, interest rate liberalization may accelerate further; on the other hand, reforms to policies related to population, household registration, and land will be a key driver of this round of economic recovery.Why do I say this? I believe that third- and fourth-tier cities have largely completed their inventory reduction tasks during the recovery process of the past few years. However, the future direction of urbanization in China lies primarily in large cities, metropolitan areas, and urban clusters—that is, with central cities as the core, driving the development of metropolitan areas and urban clusters. Everyone knows the important position of real estate and infrastructure in the Chinese economy. I believe that besides infrastructure, real estate will also play a very important role in this round of policy easing. Currently, China needs to stimulate real estate and infrastructure investment and related consumption through more market-oriented methods to bring about economic recovery, but this essentially requires a more market-oriented urbanization development strategy. In my view, the government is likely to promote the development of large cities by further relaxing household registration restrictions and increasing land supply, and then drive the development of metropolitan areas and surrounding urban clusters through the development of central cities to promote this round of economic recovery.

Many people are probably interested in our views on China's economy this year, and I basically agree.The economic trend this year is low in the first half and high in the second half. The economic downturn pressure is significant in the first half of the year, but the economy may stabilize and recover in the second half.

Thank you everyone.