Thread by @Trinhnomics

Here is a report from the World Bank on China (I used to work there before I moved to HK):

openknowledge.worldbank.org/bitstream/hand…

Look this chart (btw private sector in China is very efficient & productive & profitable compared to state sector). That said, want to see what happened to them lately & why they are not investing? Yep, not good for future growth - SOE share of credit rising while POE declines

Divergence of growth not just in terms of ownership (access to credit tilted towards the SOEs) but also the size. Look at the abnormally low access to credit by small firms relative to other BRIC & developed & world:

What about equity financing? SMEs as a % share of listed firms 👇🏻👇🏻👇🏻 ChiNext is very low, which means vs the United Kingdom, Poland, Korea, India, Malaysia, Japan etc

Check this out, despite getting loan credit + access to equity financing & low return on asset, SOEs offer the best globally in average job tenure. No wonder everyone wants to work there!

History of China reforms 👇🏻

Finally, growth scenarios for China (comprehensive reforms, moderate, and limited):

a) China growth slows no matter what
b) Question is how FAST it slows NOT WHETHER
c) Can go as low as 1.7% 2031

Implications for rates, FX, debt sustainability???

We know FOR SURE that China working age population is CONTRACTING AT ACCELERATING RATE. What we don't know is its PRODUCTIVITY growth.

So, which is it? ALL scenarios point to much SLOWER growth. Much. No V-shaped recovery. Structural headwinds too strong.

Finally, this report is signed & endorsed by the Chinese government so you know that this will be the base case scenario: China slowdown. How much? Well, average growth rates lower than 6 for all scenarios 👇🏻👇🏻👇🏻

Report has 2 key pts:
LABOR is going to decline in China (working age population declining at accelerating rate)
CAPITAL is inefficiently allocated (3 times GDP banking system) as incremental capital to output ratio (ICOR) rising & that is bad as it means capital efficiency low👇🏻

So we got LABOR change dragging down growth & we got CAPITAL allocation dragging down growth (too much debt & the productive sectors getting even more squeezed).

What's left? Economists call it PRODUCTIVITY! It's a catch all phrase for the black box. Based on the WB, that's down

Meaning, productivity would have to grow very very fast to offset the drag from labor & capital to avoid a hard landing as the best case scenario of reforms put growth at 5.1% next 10yrs & 4.1% after that & 3%.

Worst case is 4% in 10yrs & 1.7% from 2031-2014. What about rates?

Back of the envelope mental calc. China GDP is USD13trn & leverage ratio is 2.5X ex financials & ave cost of funding ~5%.

13*2.5 = 33trn of debt * .05 = 1.6trn of interest expense or ~12-13% of GDP.

Nominal growth needs to exceed this or rates have to fall over time.

The question is whether it will take the Eurozone approach of deleveraging (very similar financial system where banks are key to transmit credit). Meaning, it has to LOWER INTEREST RATES (yes, NIRP or ZIRP or very low PIRP) so that nominal growth exceeds costs of debt & delever.

How'll China take rates lower for the econ? At 1%, unlikely to be able to fall this low this yr, China interest expense'd be only 2-3% of GDP vs 12-13% currently.

Loan prime rate fell 5bps for 1yr but the 5y, which is a benchmark for loans etc, didn't fall.

Question is when...