Weekly Reports | Nov 05 2012
By Andrew Nelson
Analysts from Citi have come home from an Investor Conference in China and note the prevailing view is that the economy will probably start to stage some sort of measurable recovery in the fourth quarter. Consensus at the event is for less requirement for new stimulus measures, with the impending leadership change not necessarily indicating any significant change in direction.
There are already changes in the pipeline and these are expected to continue to flow through, although the composition of any sort of new reform agenda will only be revealed later in 2013.
However, post the event Citi is of the view the new leadership will likely accept currently slower growth to some extent, with the broker citing “most experts” as believing China's growth rate could slow to 6-8% in t he next decade. Across the nation’s economic think tanks, the general opinion is that the growth target should be set at 7.5% for 2013 in order to help re-set expectations for slower growth. Citi thinks the target my actually be set at 7% in order to both help manage the expectations of local governments, but also to leave room for structural reform where needed.
This idea of reform is an important one to keep in mind, as incoming leadership is already on the record over the importance of reform. Citi notes Vice Premier Li Keqiang, who will likely end up as premier in the new government, has already talked up the need to lift efficiency in the economy, with the current problems in China's economy needing to be solved by reform.
While official word probably won’t be issued until the 3rd plenary session of the 18th Central Committee in the northern fall of 2013, Citi reckons reform issues such as income distribution, VAT reform, interest rate liberalization, deposit insurance and capital market development, which already have broad support, will probably proceed as planned.
Citi predicts the Central Bank will possibly end up paying more attention to price stability, with the latest five-year plan on financial reform giving the PBoC a mandate to pay more attention to inflation, while also looking to increase the share of direct financing in total social financing to 15% from the current 10%.
Tax cuts are expected to be expanded and the business tax may be replaced with a with VAT, which would not only benefit service industries, but also manufacturing industries when purchasing relevant services.
Were the current reform work to be expanded nationwide, the broker thinks tax reduction could hit around about RMB400bn. SME taxes could also be further reduced, which Citi notes would benefit a wide range of businesses, while at the same time limiting tax losses.
In the meantime, analysts at BA Merrill Lynch note Local government debt in China is really starting to pile up given the ramp up in government infrastructure spending. At the same time, government revenue is coming under increasing pressure.
The broker sees this as making the country’s financial system increasingly brittle, with little relief expected from corporate taxes and fees, as an increase here would put a big dent in earnings, as Citi has already hinted above. While mutual funds and the nation’s “banking sector” (such as it is) are still funding local governments on the assumption that Beijing will backstop any bad debts, the broker sees an end to this largess approaching. “When” is the only question. As such, caution is warranted, says BA-ML.
Despite the caution, Merrills has lifted its GDP growth forecasts for both 2012 and 2013. 4Q12 yoy GDP growth is expected to come in at 7.8%, up from 7.5%, while the 2012 annual growth forecast is up to 7.7% from 7.6%. For 2013, the broker lifts annual GDP growth forecast to 8.1% from 7.6%, with 2014 expected to moderate to 7.7%. The broker cites the prospect of the green shoots growth it is already starting to see and the fact that it seeing more visible data, with previous assumptions short-selling the 4Q rebound.
Switching to a domestic focus, analysts at BA-ML notes that superannuation fees have been in a state of steady decline over the past year and 10 years, especially fees charged by retail funds. This move is a forced one, with new products increasingly price competitive with industry funds, although the broker does note average retail fund still tend to pay higher fees than industry funds.
With MySuper scheduled to kick off on 1 January 2014, the broker thinks this trend of moderating prices will continue, with lower and lower costs likely for one-investment-strategy retail products.
However, margins will undoubtedly tighten at service providers, which could rebound on investors and see more customers paying front book, rather than back book prices. Although the broker does note some retail funds could offer more than one MySuper product, which in turn could see a greater differentiation in pricing for various investment strategies. This would provide the supplier a competitive advantage against those funds only offering one MySuper option, due to the provider only having only one superannuation trust from which to work.
The is also the risk to retail investors that all of this might just end up creating nine or ten large default fund operators given scale will be key to maintaining operational efficiencies that will be necessary to offering MySuper products.
In the meantime, BA-ML reports that fund flows are showing some signs of improvement and hopes maybe we’ve seen the bottom. Yet even if this hope were true, the broker thinks it’s still too early to call a broader market turnaround, with the broker remaining Neutral on the bulk of the wealth management sector.
Credit Suisse chimes in with a bit of a sobering warning for the Australian housing market. The broker notes that the prevailing belief is that Australia has a housing shortage. On the other hand, the broker believes the market may now actually be a little bit oversupplied. CS points out home sales are at 20-year lows despite the recent rate cuts, while the country is also staring down the barrel of a weakening labour market, reductions in first homebuyers incentives, unaffordable prices and a lack of overall investor/consumer confidence.
If demand remains weak, Credit Suisse estimates house prices could fall by 15% in 2013 and dwelling commencements could fall to 100,000 or below. More rate cuts and a softer AUD are about the only thinks the broker can image that will turn things around.
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