China Moving Further Along Path to Maturity


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As China ushers in the Year of the Snake, a time for attention to detail and incremental progress, the country is poised to move further down the path to economic maturity, raising questions over its currency, a changing labor market and other crucial issues into the next decade, CME Group Chief Economist Blu Putnam said.

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China Moving Further Along Path to Maturity

  1. 1. Market nsightsBlu Putnam, Chief Economist, CME Group February 11, 2013New Year Dawns With China MovingFurther on Path to Economic MaturityChina is entering the Year of the Snake, a time for the very low productivity agricultural sector and placesattention to detail and incremental progress. In line them into the higher productivity industrial sector.with these themes, China’s economic activity seems As noted above, accommodating this migration alsoto be stabilizing at a healthy pace after a sustained requires considerable infrastructure spending – theperiod of deceleration, and its new leadership seems equivalent of building one new mega-city every year.intent on making incremental progress in several policy Currently, about half the population still lives in ruralareas, from currency normalization to health care areas. We expect the rural-to-urban migration to slow asimprovements to pollution reform. the rural population declines to under 30% of the total,For 2013, officially reported real Gross Domestic which should happen in the next five to seven years.Product is expected to grow in the 7.2% to 7.8% range. At least 3% per annum of real GDP growth is relatedThe 10% annual rate of the previous three decades directly or indirectly to this migration. So as migrationis now fading into the past, not to return (see Chart diminishes, especially in the 2020s, aggregate1.) Over the longer-term, China’s average real GDP economic activity should trend toward slower growth.growth will continue to moderate as a natural result of Third, because of the long-lagged effects of its one-past success. That is, China is on a path to industrial child policy, China is aging quickly, the labor force iseconomy maturity that integrates three powerful trends. growing more slowly, and the number of retirees forFirst, as the country has modernized at record speed, it the economy to support is growing rapidly. The futurehas naturally hit a point of diminishing returns to new course of this trend appears to coincide with the end ofcapital investments and infrastructure projects. Gains in the rural-to-urban migration in the 2020s.labor productivity are slowly shrinking, although they The two factors working together portend that Chinaremain quite positive currently. Though China will has perhaps the rest of this decade to enjoy superiorcontinue to make major infrastructure investments, economic growth before its economy transitions toas the economy matures the share of GDP growth performance more typical of a developed, maturearising from these investments will be much less than industrial country with slow labor force growth. Thatin the past. is, Chinese real GDP growth may slow to only 3% perSecond, for over a decade, China has benefited from annum by the late 2020s, starting the decade at highera powerful tide of rural-to-urban migration, around 15 growth and trending down through time.million people per year. This has taken workers fromAll examples in this report are hypothetical interpretations of situations and are used for explanationpurposes only. The views in this report reflect solely those of the authors and not necessarily those ofCME Group or its affiliated institutions. This report and the information herein should not be consideredinvestment advice or the results of actual market experience.1 market insights
  2. 2. February 11, 2013Chart 1: China Real GDP Average deep currency markets. Thus, as part of advancing the objective of currency normalization, China may beAnnual Growth by Decade. likely to also loosen controls over short-term interest rates and issue more government debt, to assist the development of rate markets. Other types of financial innovations are also likely to be encouraged, such as allowing the derivative exchanges in China to list option contracts in addition to futures. Our perspective is that financial innovations and improvements will be a hallmark of the next few years in China, because the domestic incentives are now in place to encourage such policy reforms. Other major policy initiatives over the next several years may be squarely aimed at getting the country ready for the 2020s, when growth will be slower and the aging population challenges will become severe. Tackling industrial pollution and making strides toward health care improvements will cost considerable sums ofThese three structural trends – (1) diminishing labor money, and they do not come with the same short-termproductivity returns from infrastructure and capital real GDP contributions that happen with spending onspending, (2) the slowing of the rural to urban migration basic the 2020s, and (3) the aging of the population withmore retirees and slower labor force growth – create Nevertheless, the long-term gains for the economypowerful incentives for China’s new leadership to and the overall quality of life are huge, and the politicalaccelerate normalization of the renminbi and to will-power to make these objectives high priorities istackle more quickly the related problems of industrial likely to emerge within the country’s new leadership.pollution and a health care system not yet ready for the From a financial perspective, these projects are moreimpending expansion of the retirement age population. likely to be financed with new government debt than with mandated loans to large state-run corporations,The normalization of the renminbi is important because as was the hallmark of the past decade’s infrastructureas economies mature, and as their aging populations building. Interestingly, the need to issue moreretain more wealth, there is a desire and need for government debt for pollution control and health caregreater integration with the global economy. Indeed, improvements will dovetail nicely with the need, notedChina’s next wave of productivity-enhancing efficiencies above, to develop more liquid money markets.will come in part from more financial flexibility, whilethe management of the nation’s wealth and savings will The combination of accelerated renminbibenefit from increased global diversification. normalization and expanding government debt issuance carries two implications. First, China’sCurrency normalization requires both the free currency will not be biased toward appreciation asexchange of international capital as well as developed it was in during the infrastructure-fueled growthlocal-currency money markets. Liquid and deep local boom of the last decade. With more government debtmoney markets are necessary to foster liquid and2 market insights
  3. 3. February 11, 2013issuance likely over the next few years and with money Chart 2: China’s Accumulationmarkets slowly becoming more efficient, we expectthat China will allow a greater range of movement of of Foreign Reserves.the renminbi versus the U.S. dollar. That, in turn, willdramatically dampen the authorities’ appetite forpurchases of U.S. Treasury securities.Put another way, slower economic growth, moredomestic debt issuance, and a freer currency all pointto an eventual end to building up the foreign reservesportfolio. While we do not think that China will be a netseller of its foreign reserves portfolio, just the likelihoodof slower foreign reserve growth implies an end toU.S. Treasury purchases – possibly around the sametime that the U.S. Federal Reserve may be trying tounwind its quantitative easing programs. If so, thenormalization of the renminbi may come with someunintended destabilizing implications for the U.S.Treasury securities market.CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Chicago Mercantile Exchange and Globex are trademarks of Chicago Mercantile.Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. New York Mercantile Exchange and NYMEX areregistered trademarks of the New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc.The information within this brochure has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions.Although every attempt has been made to ensure the accuracy of the information within this brochure. Additionally, all examples in this brochure are hypotheticalsituations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.Copyright © 2013 CME Group. All rights reserved.3 market insights