Growth was relatively stable in October. Industrial output was up 6.2% y/y, almost the same as in previous months. Yet key growth drivers weakened. Fixed asset investment was up 5.8% y/y, slightly above the nadir, but lower than the investment price level. So real investment growth is still negative, a key challenge for the future.

Retail sales of consumer goods were up 10% y/y in nominal terms, and 8.6% y/y in real terms. Both were the weakest growth figures of the year. Exports were up 6.9% y/y, declining from Q1 and Q2. We expect exports to continue to slide. Furthermore, the growth rate of industrial export delivery value could dip below zero next year. Imports were up 17.2% y/y, maintaining their fast growth trend, up 2.6 pps from Q3.

Producer prices continue to appreciate. The ex-factory price index of industrial output was up 6.9% y/y, and PPI was up 8.4% y/y. They grew 0.7% and 0.9% m/m, respectively. Among the composition of industrial output prices, industrial processing prices were up 7.6% y/y, a new high.

CPI was up 1.9% y/y, a slight increase, though stable from previous months. By the end of October, M2 was up 8.8% y/y, a new low, reflecting a continuation of monetary tightening.

There have been three major changes to financial regulations. On November 10th, it was announced that the government would relax or eliminate ownership limits in commercial banking, securities, futures, asset management and insurance. The same day, a cabinet-level financial stability committee was established, putting financial stability in an unprecedentedly high position. On November 19th, the Central Bank, together with all other financial regulatory bodies, issued a new guideline to more strictly regulate the asset management businesses.

Financial openness can increase the efficiency of capital allocation domestically, and can further lift the real economy’s productivity, by at least increasing financial competition among financial institutions. The Chinese government has also learned from Western countries’ past financial crisis history, by making financial stability a higher priority, since openness and liberalization are usually accompanied by instability. We view this openness with a prudential regulatory approach as a very positive direction.

Growth in Q3 was stable, though slightly lower. GDP was up 6.8% y/y, down 0.1 pps from Q2. Industrial output rose 6.3% y/y, down 0.5 pps from Q2, but still higher than in Q3 2016. However, industrial output in real terms might be worse than official statistics indicate.

Since the beginning of 2017, fixed asset investment has been weakening. It rose 9.2% y/y in Q1, then fell to 8.3% y/y in Q2, and fell further to 5.8% y/y in Q3. After taking out the price factor, fixed asset investment fell -0.6% y/y, down 5.1 pps from Q1. But the good news is that paid-in investment funds rose by a relatively large 6.7% y/y. In Q3, the real estate market quickly cooled. The sales area grew only 1.2% y/y, down 12.8 pps from Q2. Sales revenue rose 3.9% y/y, down 15.4 pps from Q2.

Retail sales of social consumption goods were up 10.3% y/y in Q3 in nominal terms, and up 9.2% y/y in real terms, both down 0.5 pps from Q2. Total imports rose 14.6% y/y, flat on Q2, still a fast-growing trend. We expect imports will continue to rise. Exports rose 6.9% y/y, down 2.3 pps from Q2.

Producer prices continue to appreciate. The ex-factory price index of industrial products rose 6.9% y/y, up 1.4 pps from June. PPI rose 8.5% y/y, up 1.2 pps from June. At the end of September, the M2 money supply rose 9.2% y/y, down 0.2 pps from June. M1 rose 14% y/y, down 1 pps from June.

China’s Communist Party held its 19th National Congress this week, where it elected its new leadership and set its main policy themes for the next five years. President Xi Jinping will remain in his post, indicating a continuation of the current policy line. This announcement has significantly reduced policy uncertainty. In his report, Xi said the next five years’ main themes would be openness, entrepreneurship and resolving inequality.

Further openness is not only an extension of Belt and Road program, but also means further welcoming FDI and financial liberalization. These areas are viewed among economists as priorities for development. Entrepreneurship is for productivity growth, which is expected to be the key growth driver, rather than investment. Inequality is a primary issue for political stability in China. The government report specifically mentions IT. The extensive use of IT may have positive implications for the economy, as IT not only improves efficiency, but also may empower the central government. It can deliver sufficient information and monitoring ability for the conduct of government policy, and lead to better policy outcomes. We are positive on China’s future growth, given the government’s objectives -- but of course we need to watch closely, to see how these objectives will be implemented.

Growth weakened in August. Industrial output was up 6% y/y, down 0.4 pps from July, and down 0.9 pps from Q2, which represented its lowest level of the year. Fixed asset investment, up 4.9%, was likewise at its lowest level of the year, down 3.4 pps from Q2.

But the ex-factory price index of industrial products rose 6.3% y/y, and was up 0.8 pps from July. PPI rose 7.7% y/y, up 0.7 pps from July. The producer price appreciation is hard to reconcile with weakening growth. We view economic fundamentals as sound, but macroeconomic uncertainty, especially driven by negative media reports, is slowing investment.

Retail sales of social consumption goods were up 8.9% y/y, down 0.7 pps from July, and down 0.8 pps from Q2. The weak retail sales can be partially explained by the crowding-out effect brought by booming housing prices. Exports were up 5.5% y/y, down 1.7 pps from July, and further down 3.7 pps from Q2. The RMB has appreciated against the dollar for four consecutive months since May, and was up more than 6%. Appreciation will negatively affect exports. Imports were up 13.2% y/y, down 0.7 pps from Q2, but will possibly increase further from RMB appreciation.

CPI was up 1.8% y/y, up 0.4 pps from July. Since we expect food price appreciation to increase further, CPI appreciation will continue as well. We expect CPI growth to exceed 2%, but be less than 2.5% y/y.

S&P Global Ratings on September 21st cut China’s sovereign credit rating for the first time since 1999, to A+ from AA-, citing the risks from soaring debt, and revised its outlook to stable from negative. We see this rating as overreaction, and misleading. Debt may not be a bad thing, especially when a country uses it to finance some long-term return projects, such as high-speed trains or urban subways, benefiting not only consumers but also firms, through market integration. We also agree with Chinese government officials’ response, that economic fundamentals are sound. Moreover, China’s external debt is small. All of these factors invalidate the claim of high risk.

Author: Fan Gang, President, CDI

Editor’s Note: China’s low levels of consumption can be partly explained by the fact that consumption accounts for a rather small share of income, with China’s current household spending representing only 40% of GDP and the combined spending of government and consumers accounting for only 55% of GDP, and partly by high savings rate. In 2007, the national savings rate reached a record high of 51%. In recent years, despite efforts to reduce the proportion of savings and increase consumption, the national savings rate remains elevated at around 45%. Aside from household savings, corporate savings and government savings also matter. Corporate savings usually refer to profits that are not spent. Deposits of some large SOEs may total up to tens of billions of yuan, and yet they choose to save them with the SASAC (State-owned Assets Supervision and Administration Commission) rather than share the dividends or turn them over to the national treasury. Therefore, over the past decade, money has added up in bank accounts. And one motive behind the Belt and Road Initiative is to tackle high savings rate. China’s consumption is actually suppressed against such backdrop.

Drivers for Consumption Growth

Income growth is the most important driver for consumption growth. Countries with high consumption must also be high income countries. China is still a middle-income country with per capita GDP of 8000 dollars, while the per capita GDP of the United States is over 50,000 dollars, and that of Norway is 100,000 dollars, which ranks 1st in the world. As a developing country, China’s consumption surely needs to become stronger. An increase in earnings among people with lower income, who demonstrate higher elasticity of consumer demand, will contribute to faster consumption growth of the society as a whole.

Credit consumption and finance are also driving forces behind consumption growth, which have seen rapid growth with the development of P2P platforms and Internet finance. Online mobile phone purchased by university students constitutes a short-term small consumer credit. China's consumer credit has surpassed industrial loans to become the largest sector in the banking system with 26% of share.

E-commerce has also fueled consumer spending. Presently, delivery reaches not only urban areas but also the countryside. These delivery vehicles are loaded with consumer goods.

Patterns of Consumption Growth

First, though the Chinese appetite for material consumption is far from been satisfied, service consumption has begun to grow. With growing income, people begin to have more disposable income to spend, with the consumption of physical goods seeing the fastest grow that the moment. Meanwhile, service consumption has begun to see substantial growth as well. The service industry has become the largest industry in China today. Transformation from diversified consumption to the service industry is taking place and gaining momentum.

Second, traditional consumption and new types of consumption are both on the rise. Basic needs such as those for housing and family life have not been met. 70% of the Chinese are the low-income class, of whom 34% are farmers. As their income grows, many of them will first try to meet their basic needs, thus generating great market potential in traditional consumption. An important driving force behind this process is urbanization, which obviously is related to the property market. As people migrate, their housing needs change accordingly. Farmers want to buy houses in the county as they move in from the countryside. County residents prefer to live in prefecture-level cities, as those in prefecture-level cities seek personal development in provincial capitals, whose residents decide to try their fortunes in megacities. As the country urbanizes, its people are moving from one house to another.

In a way similar to housing, the consumer market follows where people move. During the urbanization process, new types of consumption, such as consumption of entertainment, culture, health and education are also growing faster and the share of the service industry will be even larger. According to the big data provided by international credit card companies, the growth of high-end service industry is the future trend, while the consumption of goods will be more diversified, refined, functional and ritualized, which will inevitably create a lot of demand, such as people’s demand for professional sportswear.

Finally, it is worth noting that China's retirement consumption has just begun. With an aging population, there is still a long time between retirement and old age requiring elderly care. Perhaps people will begin to need elderly care only in their 80s. If they are 60 years old now, there will still be 20 years ahead to enjoy and to consume before old age. China’s new-generation retirees are just emerging, who, benefiting from high economic growth brought by reform and opening-up over the past 30 years, have become China’s middle class. Before retirement, many of them have money but little leisure time, but now as they have both, the party of retirement consumption will begin.

Author: Qu Jian, Vice President, CDI

Editor’s Note: Overseas economic and trade cooperation zones have become important vehicles and platforms for Chinese mainland companies investing oversea and building relationship with foreign partners. Hong Kong's strength as an international finance center with an open market in the scope of specialized services, from financial investment to logistics and shipping, capital construction management, legal arbitration, and to regional businesses, has played a massive role in the investment and construction of "The Belt and Road" overseas industrial parks.

First of all, most of the capital for the expansion of overseas industrial parks is raised from the market. Hong Kong can provide professional services like complete specialized project valuation and sustainable development estimate for Chinese mainland companies investing in the countries along the B&R to introduce external funds and finance overseas investment projects or other businesses. What’s more, the service platforms in Hong Kong can offer mainland companies a multitude of investment ways, such as, private equity investment funds, equity joint investment, or other joint stock cooperation, thereby enabling them to spread risk.

For another, the construction of overseas economic and trade cooperation zones has accelerated the industrialization and driven related industries and economic development of the host countries along the OBOR. In addition, the successful experiences of the Shenzhen Special Economic Zone and the Hong Kong institutional system can further help host nations to establish special economic zones. The establishment of industrial parks abroad needs one statute, two plans (industrial planning and spatial layout planning), three schemes (business scheme, financing scheme, management and operation scheme). The returns on financing and investment that involve with these three aspects above highly coincide with the financial industrial of Hong Kong. Given that Hong Kong’s financial industrial offers financial services for Chinese investors to explore the markets in laggard developing countries along the B&R, it will tremendously spur the economy of these countries and encourage more enterprises from Chinese mainland to invest abroad.