Financial Services Focus Group Quarterly Update – Q1 2016

Published on 2016-04-19

In this Update you will read about Economic Development, Highlights from the 2016 National People’s Congress, Shift from Business Tax to VAT, Shanghai Insurance Exchange.

Economic Development

First Quarter 2016 data has provided some relief that the Chinese economy is reacting positively to Government stimulus steps.

China’s economy grew 6.7% in 1Q16 from a year earlier, compared to 2015’s 6.8% growth in Q4 and 6.9% in Q3.  March data is often skewed by the effect of the Chinese New Year holidays (e.g. industrial growth in March exceeded expectations at 6.8%), so the trend in Q216 will be more significant.

Consumer prices in China rose 2.3% year-on-year in March 2016, the same pace as in February and below market consensus of a 2.5% increase.  Food prices increased by 7.6%, non-food cost rose at just 1.0%, consumer goods gained 2.5% and service prices grew 1.9%.

Fixed asset investment (government spending on infrastructure) increased by 10.7% compared to 1Q15.

Industrial output increased by 5.8% and retail sales at 10.5% also came in ahead of expectations.

Credit growth is a growing concern and was estimated by foreign economists to have doubled compared to the same period in 2015, surging more than expected in March; new bank loans jumped to RMB1.37 trillion (US$211 billion) and total social financing -- a wider measure of credit in the real economy – rose to RMB2.34 trillion.

Housing showed signs of recovery in 1Q16.

Non-performing Loans due to the recent economic slow-down is a continuing concern as mounting corporate bank loans that are at risk of default.  Although expected economic growth should enable NPLs to remain “manageable” (according to the IMF), the scale of corporate debt vulnerability (US$1.3 trillion) indicates the need for ongoing strengthening of financial institutions.

China’s Credit Rating was cut by Moody’s from Aa3 Stable to Aa3 Negative; S&P also changed ratings from stable to negative, commenting that Government and corporate leverage ratios are likely to deteriorate, and the investment rate could be well above what it believes to be sustainable.

Highlights from the 2016 National People’s Congress (NPC)

GDP is planned to grow by 6.5%-7.0% in 2016, meaning that China aims to create additional nominal GDP value of about RMB6.6 trillion to reach RMB90 trillion.

Inflation (CPI) is targeted at 3.0% for 2016.

M2 money supply target is set at 13%, up from 12% in 2015.

China’s fiscal deficit is budgeted as 3.0% of GDP or RMB2.18 trillion, higher than 2015’s actual deficit of RMB1.35 trillion (2.1% of GDP).

Government Investment is planned for RMB2.45 trillion, RMB800 billion on the hi-speed rail network increasing it by 60% to cover 8 out of 10 major cities - and RMB1.65 trillion for highway investment (an increase of 25%).

No ‘big stimulus’ plans, although RMB500 billion of deficits will stem from lowering the tax burden (see VAT para below).

Employment pressure will arise from cutting excess capacity in sectors such as steel and coal where 1.8m layoffs are expected over 5 years; the service sector is expected to help absorb excess labour, having created 12 million jobs in 2015; the plan is to continue to shift growth from investments and exports to consumer spending. 

Urbanisation rate will rise to 60% (currently 56%) adding 100 million registered urban population over the next 5 years.

Shift from Business Tax to VAT

The Government has been transforming its Business Tax into a Value Added Tax since 2012 and in 1Q16 announced that the four sectors of construction, real estate, financial services and consumer services will be included from 1st May 2016.  Although the overall tax burden to companies should be reduced (the previous changes had already brought it down by RMB600 billion), the implementation will lead to some companies potentially paying more tax with an additional administrative burden during the changeover for all affected companies.  Moreover, the lead time for implementation is short.  This ongoing reform aims to shift the tax burden from companies to consumers, helping to modernise the tax collection system and support the growth of the service sector.

Shanghai Insurance Exchange

The China Insurance Regulatory Commission (CIRC) recently confirmed that an insurance exchange will be set up in Shanghai as part of the Central Government's plan for Shanghai to become an international financial centre.  The proposed insurance exchange will initially provide a centralised trading platform for reinsurance, property and liability insurance, and group life insurance with risk securitization products, such as catastrophe bonds and insurance derivatives being added at a later date.

In addition, the insurance exchange may provide information relating to insurance brokers, insurance assessors and other insurance intermediaries.  It is thought that participants in the exchange will include life insurers, property and casualty insurers, reinsurance companies and insurance intermediaries.  It remains unclear as to whether foreign insurers will be allowed to trade on the insurance exchange.

Although the exchange is part of Shanghai's aim of becoming an international insurance center by 2020, it must be said that other countries’ attempts to create an exchange mirroring Lloyd’s of London have so far proved unsuccessful.