Submitted by Zarathustra of Also Sprach Analyst [12],
All major macro data from China [13] over the last 2 days have been disappointing.
The third quarter started on a surprisingly weak note for China [13] despite all the talks (and hope) on stimulus and monetary policy easing.
The macro data pretty much confirm our view that economic growth did not reach a bottom in the second quarter [14] as the consensus used to believe.
If anything, the economy [15] seems to be worsening somewhat again.
Wrap up of July macro data:
CPI Inflation +1.8% yoy, PPI –2.9% yoy [16]
Industrial production +9.2% yoy [17]
Fixed asset investment +20.4% yoy [18]
Exports +1.0% yoy, Imports +4.7% yoy [20]
New loans +RMB540.1 billion [21]
After these weak numbers pointing to hardly any recovery, we believe that the market will step up their talks on further and more aggressive stimulus both on fiscal and monetary sides, and we suspect that the consensus will be shifting from believing in a Q2 bottom to a Q3 bottom (which has been happening for a few quarters now: the economy [15] will recover next quarter, said everyone in every quarter).
There is very little doubt, to our mind, that this series of weak numbers will put more pressure on the government to ease policy further. However, let us review a few facts: the People’s Bank of China has already cut interest rates twice and RRR has been reduced three times since late last year. The government has expressed their intention to bring future investment projects forward, and now that growth is their top priority.
On top of that, local governments have been, in the last few months, announcing massive plans to stabilise growth [22], and some have suggested banks to lend to local governments for growth stabilisation purpose [23].
Surely, many of these have not been implemented (especially the local governments stimulus), and we still have no idea just how much of these investment plans will actually come through. However, with the easing that has been done, obviously it is not working yet. This is consistent with our belief that it will require much more stimulus in order to ensure growth can get above 8% [24]. What have actually been implemented (mainly in forms of interest rates and talks of stimulus) were far from what we would regard as “enough”.
The problems that are left now is whether the government is willing to stimulate the economy like crazy (as they did in 2009), and whether the government still has that ability.
Is the government willing to stimulate the economy like crazy?
The answer, unfortunately, seems to be no, not quite.
As we mentioned for a number of times, the fact that the real estate market warming up in the past few months [25] has already caused some concern. While the government is not likely to implement extremely harsh measures to curb home prices at this point as the economic slowdown is getting much worse than most expected, it is not likely that they would like to ease either. As we believe that it is next to impossible to ease policy to stimulate growth while at the same time cool the real estate [26] market, this leaves the government in a position that limit their willingness to implement full-on easing.
The on-going drought in the US [27] is also going to delay more aggressive stimulus and monetary easing. As we noted before, meat prices in China tend to lag global corn prices [28]. With corn prices reaching a record, it will probably put some inflationary pressure on food prices later this year. Although inflation in China on an ex-food basis is low and is expected to remain very low owing to massive over-capacity [29], food prices account for 30% of China’s CPI basket, and food prices have been historically very volatile in China. Thus while “core-inflation” will be low or negative in medium to long term, inflation in food prices will probably have reached a short-term bottom and is set to rebound somewhat. Although we are not expecting headline inflation to go back to 4.0% yoy all of a sudden within 2 or 3 months, a rebound in food prices will undoubtedly limit the perceived room for policy easing.
Does the government actually have the ability to stimulate the economy like crazy?
Of course, we would accept that the government will be willing to do more when things turn even worse. In fact, this is probably what the market has been expecting for every major central bank: just print more money when things look bad. Thus the more important question to consider is whether the Chinese government and central bank really have the ability.
The consensus invariably believes that China “has a lot of room to stimulate the economy”, “has a lot of tools at its disposal”, etc. This could not be further from the truth.
The latest data actually confirm the point. Loan growth is not really picking up after interest rate cuts, and deposit growth remains weak. Meanwhile, prices pressure continues to subside, with PPI falling 2.9% yoy. This actually fits into our debt deflation call [30] surprisingly well.
Meanwhile, we noted that China has record rather consistent capital outflow since late last year, and this picture has been confirmed in the balance of payments, which showed that China had the first BoP deficit since 1998 [31]. As explained in more detail in our guide to China’s monetary policy [32], central bank creates money to prevent Chinese Yuan from appreciating during the period of inflows and massive trade surplus, thus creating more liquidity in the banking system. The opposite will happen: central bank withdraw money from the foreign exchange market to prop up Chinese Yuan (as they have been doing recently), thus tightening monetary condition. It is true that the central bank can cut reserve requirement ratio (as they have done for a few times) to offset, but cutting RRR is not real easing, and there is only so much the PBOC can cut (i.e. about 20% or so).
In theory, the government can run much higher deficit (and run up larger debt) for the sake of creating growth with a fiat currency. But with a peg like it is now, with smaller trade surplus and capital outflow, that severely limit the central bank’s ability to ease credit. Although government directed lending (i.e. government forcing state-owned banks to lend) is a key tool within China’s monetary policy toolbox, Chinese exchange rate regime (as it currently stands) limit the ability for banks to extend credit when the country is facing shrinking trade surplus and capital outflow, even if the government wants them to.
Staring down the bottomless pit
We hope that the consensus is (finally) right and that we are wrong. We hope that we will not be repeating the joke that “the consensus is expecting a recovery in next quarter during every quarter”.
Unfortunately, we just don’t see that, and we doubt if the government has the willingness at this point to do much more, and we doubt whether the government really has the ability as the market thinks. We do not see convincing signs of recovery (except, perhaps, Wen Jiabao making waves every other week), and we even struggle to see signs of stabilisation.
If we see anything, we are seeing a bottomless pit.