As the U.S. prepares to take China to task over trade imbalances, economic mandarins in Beijing are focusing on a potentially more immediate threat from Washington — Donald Trump’s tax overhaul.
In the Beijing leadership compound of Zhongnanhai, officials are putting in place a contingency plan to combat consequences for China of U.S. tax changes as well as expected interest-rate increases by the Federal Reserve, according to people with knowledge of the matter. What they fear is a double whammy sapping money out of China by making the U.S. a more attractive place to invest.
Under the plan, the people say, the People’s Bank of China stands ready to deploy a combination of tools — higher interest rates, tighter capital controls and more-frequent currency intervention — to keep money at home and support the yuan.
An official involved in Beijing’s deliberations called Washington’s tax plan a “gray rhino,” an obvious danger in China’s economy that shouldn’t be ignored. “We’ll likely have some tough battles in the first quarter,” the official said.
Central to officials’ fear is the yuan, which has just regained its footing after enormous government efforts to prop it up. Should the yuan lose steam again, the thinking goes, it could further exacerbate capital outflows in a vicious cycle.
The sense of urgency illustrates Beijing’s challenge in battling policies rolled out under Mr. Trump’s “America First” banner.
A stronger U.S. economy is generally seen as a positive for the rest of the world, including China. A global recovery led by the U.S. has been a shot in the arm for Chinese exports, helping Beijing dodge a slowdown many had expected to hit this year. However, a series of trade penalties being readied in Washington are likely to complicate the windfall for Beijing from rising U.S. demand.
While the tax overhaul isn’t directly aimed at Beijing, it is another way China will be squeezed.
Under the tax plan now going through the U.S. legislative process, America’s corporate levy could drop to about 20% from 35%. Over the next few years, economists say, that could spur manufacturers — whether American or Chinese — to opt to set up plants in the U.S. rather than China, where total tax burdens on companies are among the highest of major economies.
In practice, tax experts say, Chinese companies typically pay taxes on about 40% to 50% of their profits after various deductions. Tax experts say the average U.S. rate after deductions is lower than that.
In the near term, expectations for such moves could cause money managers and others to move money out of emerging markets like China and instead park the funds in the U.S. Potentially adding to the migration of funds is rising expectations that the Fed will raise rates this week and continue such actions into next year.
Data from the Washington-based Institute of International Finance show that investor fund flows to emerging markets turned sharply negative late last month due to heightened expectations for the U.S. policy moves.
Gene Ma, China economist at the institute, said the impact on China ultimately will depend on the soundness of its own economy.
“Money was ready to leave in 2015 because growth and confidence were both very weak,” Mr. Ma said, referring to an unprecedented $676 billion in estimated outflows from China that year following a stock-market crash and a surprise currency devaluation. “Things are better now.”
Tighter restrictions on money leaving China helped stem outflows and stabilize the yuan, which so far this year has recovered most of the ground it lost against the dollar in 2016. Improved faith in Chinese growth, now on track to handily meet Beijing’s target of around 6.5%, has also helped keep money from fleeing.
But the outlook appears hazier in light of an expected slowdown in both property and infrastructure investments. Meanwhile, debt continues to pile up in the economy, leaving it vulnerable to a prolonged downturn unless the government takes more forceful measures, economists and analysts say. Official data released Monday show that while total credit growth dropped in November, as regulators forced banks to bring off-balance-sheet credit onto their books, bank lending jumped.
With these unresolved issues in mind, Beijing is sensitive to any threats that could cause a repeat of market turbulence seen in 2015 and 2016, Chinese officials say. President Xi Jinping has publicly urged authorities to limit the potential “spillover effects” from policy actions overseas. It’s a topic likely to be discussed at a high-level meeting early next week to map out Beijing’s economic agenda for 2018.
Under the contingency plan now being prepared, one course of action China’s central bank could take involves gradually guiding up costs for bank-to-bank borrowing, which has significantly added to financial risks in recent years, while leaving unchanged benchmark interest rates so as not to make it too difficult for companies to borrow or pay back debt, both of which could hurt growth.
“The PBOC likely will be biased toward a tighter monetary stance in the first quarter,” said Zhu Chaoping, a Shanghai-based global market strategist at JPMorgan Asset Management.
The officials involved in the discussion underlined that the planned measures may not be needed if the U.S. tax plan or interest-rate moves have limited impact on Chinese outflows.
Some economists and analysts are also calling on China to take advantage of its still relatively strong growth to renew its efforts to foster freer cross-border fund flows and have a more flexible exchange rate.
“The government may act opportunistically to loosen capital controls subject to the strength of inflows and vice versa,” said Gene Frieda, a London-based global strategist at the Pacific Investment Management Co. Using a phrase from the movie “The Karate Kid,” he called it “a version of wax on, wax off.”
The sweeping overhaul of the U.S. tax code, estimated to result in $1.4 trillion in U.S. cuts over a decade, is also serving as a wake-up call for Beijing, which for years has dragged its feet on revamping China’s own rigid tax system. Chinese businesses have long complained about high taxes, and the government has pledged to reduce the levies on them. The contingency plan currently in the works doesn’t include any significant tax reductions, the people involved in the discussions say.
While U.S. companies pay a higher national income-tax rate — 35% versus 25% in China — Chinese companies face a welter of other taxes and fees their U.S. counterparts don’t, including a 17% value-added tax. And while Chinese firms don’t pay state taxes, as U.S. companies do, Chinese employers pay far-higher payroll taxes. Welfare and social insurance taxes cost between 40% and 100% of a paycheck in China.
World Bank figures for 2016 show that total tax burden on Chinese businesses are among the highest of major economies: 68% of profits, compared with 44% in the U.S. and 40.6% on average world-wide. The figures include national and local income taxes, value-added or sales taxes and any mandatory employer contributions for welfare and social security.
Source: Dow Jones