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China on track for rebound as economic data improve
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China’s economy appears to have stabilized after June’s financial market volatility. The government blinked in the face of financial stress and eased monetary conditions. This easing, coupled with an export rebound, spurred economic activity in August and should ensure a third-quarter rebound.
The first half of 2013 was a period of implicit monetary tightening and withdrawal of liquidity in China. This resulted in slowing GDP growth and industrial production, low inflation, and a flattening bond yield curve. The tightening was driven by the new administration led by Premier Li Keqiang, who wanted to crack down on the shadow banking sector, reform the financial system, and cool the housing market.
This came to a head in June, as global markets began considering the possibility of the US Federal Reserve tapering its asset purchase program. Interest rates rose for longer-dated US Treasuries and the “carry trade” — where funds were borrowed cheaply in the US and lent in higher yielding emerging markets — reversed. This additional reduction in liquidity froze China’s interbank lending markets and the Shibor reached a record high.
The increased potential for financial stress to affect the real economy prompted the central government to backpedal on its tightening policy. The central bank increased its open market operations and pledged to safeguard stability in money markets. Premier Li Keqiang and other officials pledged a 7 percent “bottom line” GDP growth rate and announced a “mini-stimulus” composed of various measures targeted at exporters and railways, among other areas.
The global carry trade is still unwinding, as seen in the recent market selloff in Indonesia, India and other emerging markets. In China, financial conditions have stabilized but have not fully normalized. Shibor is much lower than its peak but still higher than it was in the first quarter. The government appears to have endorsed a recovery in credit growth and in certain types of shadow financing, such as bankers’ acceptance bills, which increased in August after three months of decline.
The actions have put a floor under growth. Three series that Premier Li reportedly looks at — electricity consumption, rail freight volumes and bank lending — are trending higher. There was a notably broad improvement in China's August data. Manufacturers’ confidence, retail sales, exports and industrial production all improved, as did fixed investment.
Based on data for July and August, our tracking model points to GDP growth accelerating to 7.9 percent year on year in the third quarter, up from 7.5 percent in the second. The actual result could be below that estimate, because September is likely to see some pullback from August. Higher than expected inflation suggests that August activity was above trend, in our view.
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