China overcapacity darkens Asia's 2016 growth prospects — ADB

BEIJING — Huge industrial overcapacity in China will drag on both the country's and the region's growth this year, the Asian Development Bank (ADB) said this week, cutting its forecast for the world's second-largest economy.

China's gross domestic product (GDP) growth is expected to slow to 6.5 per cent in 2016, the ADB added in its flagship Asian Development Outlook, lowering its December forecast of 6.7 per cent.

With China casting its shadow over the continent, the bank also reduced its prediction for Asia's growth to 5.7 per cent, down from 6 per cent and slower then last year's actual 5.9 per cent expansion.

China's "growth moderation and uneven global recovery are weighing down overall growth in Asia", said ADB's chief economist Shang-Jin Wei.

The document comes at a time of global uncertainty about Beijing's ability to make much-needed cuts to its steel, coal, and cement sectors and manage a tough economic transition to a more consumer-led model.

China's economy grew at its slowest pace for a quarter-century last year, and concerns have been mounting it could soften further after Beijing set a 6.5-7 per cent target for 2016.

"Weak external demand and excess capacity in some sectors, on top of a shrinking labour force and rising wages, continue to induce a gradual decline in the PRC's growth rate," Wei indicated. 

A "sharp slowdown" in Chinese real-estate investment will be a "drag" on the economy, the bank said, although it would be partly offset by consumption and green investment. 

The ADB's China economics head Jurgen Conrad stressed that the government "urgently needed" to accelerate cuts to excess capacity in real-estate and manufacturing, and cited high corporate debt as another challenge. 

"Supply-side reform is what China needs and what Asia needs," he said, adding that Beijing would not use "shock therapy" to make changes.

India outpacing China 

Elsewhere across the continent the prospects were brighter, however, according to the Manila-based bank.

The ADB predicted growth in India, the fastest-expanding large economy in the world, would slow to 7.4 per cent, from 7.6 per cent in 2015, but would accelerate again to 7.8 per cent in 2017. 

"India is growing faster now than China... and is likely to remain so in the near future," Wei said, saying structural reforms and improvements to labour market regulations would help boost activity.

Indonesia will lead Southeast Asia as Jakarta ploughs cash into infrastructure and encourages private investment, the ADB indicated, predicting GDP would grow 5.2 per cent this year, up from 4.8 per cent in 2015.

China's heavy industries, many of them state-owned, have provided mass employment for tens of millions of people but are increasingly loss-making and debt-ridden.

Shutting inefficient companies could cause further problems, the bank said, potentially leading to 3.6 million job losses and drying up tax revenues for local governments. 

"What China is now attempting to do, in terms of the transformation of the economy, is absolutely unprecedented in human history," China country director Hamid Sharif said in Beijing. 

"We know from the experience of other countries that reform is very much an art, and not a science," he added. 

"In every country, decisions have to be made taking into account what is possible, and what is achievable, rather than what some theoretical economist may sit in a room and decide ought to be done," Sharif elaborated.

In the long-run, the bank warned China faces a demographic squeeze as the population ages, which increases pressure on authorities to act now to reform the economy. 

"Rising wages... and shrinking working age population are fundamental reasons why there will be a slowdown," ADB chief economist Wei told reporters in Hong Kong.

Separately, ratings agency Standard & Poor's (S&P) cut its outlook on China from stable to negative on Thursday, warning that economic rebalancing was taking longer than expected.

"The economic and financial risks to the Chinese government's creditworthiness are gradually increasing," it said in a statement.

S&P kept its rating on Chinese sovereign bonds unchanged at AA-/A-1+.

Beijing is grappling with a tough economic transition away from dependence on heavy industries toward a consumer-driven model, but fluctuations in the exchange rate and stock markets have undermined confidence in leaders' willingness to push through reforms. 

S&P added that it could downgrade Chinese government bonds this year or next if Beijing tries to keep economic growth at 6.5 per cent by opening the credit floodgates and pushing investment to above 40 per cent of GDP.

That would be "well above what we believe to be sustainable levels of 30-35 per cent of GDP and among the highest ratios of rated sovereigns", which it noted would weaken the economy's resilience to shocks.

The US-based agency also said its downgrade was motivated by its view that much-needed reforms to hulking, inefficient state-owned enterprises may be "insufficient" to reduce the risks of credit-fuelled growth. 

It projected the economy would expand at 6 per cent or more over the next three years, but forecasted that government debt would rise to 43 per cent of GDP. 

But it said ratings could stabilise if Beijing takes measures to cool credit growth so that it is more in line with nominal GDP.

A lowered outlook does not necessarily mean there will be a downgrade of Chinese bonds, which would push up borrowing costs for Beijing in international markets. 

Chinese stock futures fell after the announcement on Thursday evening, but analysts said the outlook cut was unlikely to weigh heavily on markets. 

"I don't see this as a game changer," NordineNaam, global macro strategist for Natixis SA told Bloomberg News, adding he did not expect "any major impact".

"While things will remain difficult, we're expecting fiscal stimulus in the coming months that will be supportive of growth," he said.

China's foreign exchange reserves, the world's largest, fell to $3.2 trillion in January, the lowest in more than three years, official data have showed.

S&P pointed to increased global use of the yuan and ambitious plans to increase fiscal transparency as positive signs for the economy, while noting that a history of uneven implementation and a lack of "checks and balances" or a "free flow of information" could lead to distortions and "foster discontent over time". 

S&P joins fellow ratings agency Moody's, which cut its outlook on Chinese sovereign bonds in March, citing increasing capital outflows and rising debt. 

After the Moody's downgrade the official news agency Xinhua carried a commentary criticising the "short-sightedness" of Western ratings agencies, and claiming they lacked credibility and significance.