The document discusses risks to China's economic outlook that have recently intensified. It notes that while the government's long-term reform agenda remains positive, short-term cyclical risks from low growth have increased. Specifically, the budget aims to stimulate local investment but nearly half is dedicated to supply-side reforms, and there are few drivers of growth other than infrastructure and housing. Additionally, the housing market faces risks of excessive leverage and a potential price collapse if the government cracks down on liquidity. Overall the risks to China's outlook have grown and now hang in a delicate balance.

1. 1
1Q 2015
2016
AB FIXED INCOME INSIGHTS
RISKS TO CHINA OUTLOOK INTENSIFY
+ Hayden Briscoe, Director—Asia Pacific Fixed Income
+ Anthony Chan, Asian Sovereign Strategist
+ Jenny Zeng, Head of Credit Research, Asia
Our view on China has always weighed the short-term cyclical risks of low growth against the long-
term structural benefits likely from economic reform. Recently, these risks have grown. While our
overall view hasn’t changed, the risks now turn on a knife edge.
A consistent theme in our China research has been to
acknowledge the risks inherent in the country’s plan to
rebalance its economy from an investment-driven model to one
in which consumption plays a greater role.
Such a transition is always challenging—the more so in
China’s case, as it involves the need to negotiate a path
between the status quo of a single-party state and the brave
new world of a more open economy, while all the while
maintaining social stability.
In this context policy risk, in our view, has always been the key
risk to watch.
It came to the fore last year when the government tried to limit
fallout from a correction in the equities market, and the
People’s Bank of China (PBOC) mishandled communications
around a minor adjustment of the renminbi (RMB) relative to
the US dollar.
Last month, it resurfaced in the Budget for 2016 announced at
the National People’s Congress. For those looking for
stimulatory measures, the Budget appeared at first sight to
deliver: headline items included a flexible GDP growth rate of
6.5% to 7.0% and a continued easing bias in monetary policy.
The full picture, however, was more nuanced and less
encouraging.
BUDGET TREADS A FINE LINE
Our analysis showed that nearly half of the planned fiscal
shortfall consisted of tax cuts, reductions in business imposts
(to boost competitiveness) and provision for redundancy
payments expected as a result of cuts to overcapacity in heavy
industries.
In other words, a high proportion of the Budget was dedicated
to pushing through the government’s supply-side economic
reforms, with the balance aimed at stimulating local investment
demand, mainly through support to the infrastructure and
housing sectors.
We support the government’s reform agenda and continue to
believe that policy makers have sufficient flexibility to “muddle
through” and avoid a hard economic landing, at least over the
next one to three years.
That said, there is no avoiding the reality that supply-side
reform in the current national and global economic environment
is a high-risk undertaking for China, particularly within the
contradictory—or at least ambiguous—policy framework
reflected in the Budget.
The policy risk posed by the Budget, in our view, is that it
creates the potential for a vicious and ultimately self-defeating
cycle, in which more stimulation for housing and infrastructure
leads to a compensatory response in the form of more
aggressive implementation of supply-side reform.
We’re not aware of anyone having upgraded their growth
forecasts for China in light of the Budget; that’s not surprising,
given the potential for a zero growth outcome which is at least
theoretically possible, based on its policy settings alone.
From a real-world perspective, however, we believe that the
risks could be more to the downside, because there are few if
any drivers of growth in China at the moment other than
support for the infrastructure and housing sectors.
China’s exports are deteriorating sharply in the absence of a
recovery in external demand, and consumption—which has
grown as part of the overall economy—may begin to fade as
export income falls further and supply-side reforms cause
redundancies and uncertainty about job security.
These policy risks are compounded by what we see as
resurgence in cyclical risk, particularly in the housing market.
NOT SAFE AS HOUSES
So far this year, average sale prices for residential properties in
Beijing, Shanghai and Shenzhen have risen by 31%, 26% and
74% respectively. Even by Chinese standards, these are
exuberant increases.
The real worry lies in the lack of fundamental demand: despite
the wild price rises, there has been little if any pick-up in land
bank purchases. Instead, the dynamics appear to be risk-
aversion—investors returning to the perceived safety of real

2. AB FIXED INCOME INSIGHTS APRIL 2016
2
estate after experiencing volatility in the equity and bond
markets—and leverage.
This is being provided in the form of down-payment loans by
real-estate agents, peer-to-peer lenders, wealth management
products and developers. The size of this debt market—which
is confined mainly to Tier 1 cities—is difficult to gauge, with
anecdotal evidence suggesting it could be anything between
RMB2 billion (US$310 million) and RMB1 trillion.
Our own research suggests that the total outstanding balance
of down payment loans is more in the range of RMB140 billion
to RMB320 billion. This is small compared to the existing pool
of household debts and mortgages and does not in itself, in our
view, represent any risk to the financial system.
There are clearly risks to the housing market, however. From
the information that we’ve been able to piece together, we
estimate the value of property sales supported by leveraged
down payments in the primary market to be in the range of
RMB605 billion to RMB1.2 trillion. Note that sales growth last
year was 16.6%, far in excess of our forecast of 2.0%. This
suggests at least half or perhaps all of last year’s sales growth
could be attributed to excessive leverage.
The housing market is now on a knife edge of its own following
action by the Chinese government to suspend down payment
lending and investigate the practice. If our analysis is correct,
we think it’s reasonable to assume much weaker contracted
sales growth in 2016 than is currently expected. Market
consensus is looking for volume growth this year of 7% to 10%;
we think a contraction of 6% is likelier, with no growth in
average sale prices.
The likely broader impact of this is hard to assess at the
moment, as it depends on how the government handles the
issue. The worst case, in our view, could be a crackdown on
the liquidity available for property purchase, which would
trigger an equity-like collapse in the property market, with
prices potentially falling 20% to 30%.
Our base case is more benign: we think it likelier that the
government will try to cool the property market in specific cities
by administrative measures (such as stepped-up
implementation of house purchase restrictions) while
maintaining sufficient liquidity in the whole system. Such an
approach, in our view, would lead to a rationalization of
property purchases without price disruption.
ROAD TO REFORM GETS BUMPIER
As already noted, we remain optimistic about China’s long-term
prospects, which depend on the government’s ability to
navigate the road to reform. Clearly, however, the road has
become a lot bumpier as a result of the risks outlined above.
We think the knife-edge metaphor for the short-term outlook is
justified, given that policy priorities are unclear if not confused,
and that risk in the housing market—especially in Tier 1
cities—is high.
From a global macro-economic perspective, this means that
that the recent run-up in certain commodity prices, to the extent
that it reflected expectations of a Chinese residential building
boom, was based on false optimism.
For global investors who have China on their radar, it
reinforces the message that rigorous, on-the-ground research
and careful securities selection are essential for appropriate
appraisal of risks and opportunities. In the current environment,
we think the risks warrant particular attention.

3. 3
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