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August 2, 2013

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Home » Business » Biz Commentary

New tools ready to arrest slowdown

By Dariusz Kowalczyk and Gary Yau | August 2, 2013, Friday | Print Edition

In the  summer of 2012, having argued that the Chinese economy would be fine that year, we felt rather lonely. This summer the same chorus of doomsday prophets, that predicted a hard landing last year, are at it again. Maintaining our 7.7 percent call for 2013 GDP growth puts us decisively at the upper end of the consensus.

Our confidence reflects purely the ability and willingness of China’s policymakers to achieve its growth target. Both will be needed given slower momentum and a deterioration of sentiment in the mainland, palpable during our visits to clients earlier this month. It was striking to see the degree of caution, if not pessimism, among the clients we met.

As recently as January the mood on the ground was quite upbeat, but by April it had begun to deteriorate and in July we mostly heard concerns about the economy. The optimistic interpretation of our conversations is that there was still confidence that GDP would grow by 7.5 percent this year, which should be comforting for global investors in the short run.

On the other hand, clients expect a slowdown in the long run perhaps to levels that would have everyone dependent on Chinese demand quite worried.

The deterioration in mood was caused by the realization that the government is serious about restructuring the economy, which involves short-term pain. Policymakers are dealing not only with social stability and government waste, but also with environmental risks and excessive financial leverage.

In June, revenue growth of industrial enterprises slowed to 7.3 percent year-on-year and profit growth to 10.7 percent, versus eight-year averages of 25.3 percent and 22.5 percent, respectively. However, such measures are necessary and will be expanded. The color and smell of the air in Beijing, breathed in by an increasingly environmentally aware population, will force better conservation of natural resources.

Businesses have other reasons to worry. The cost of financing increased sharply and access to it deteriorated following the June cash squeeze in the interbank market and conditions have not yet returned to normal. As a result, corporate bond issuance became not just scarce, but also much more expensive.

Liquidity squeeze

In June, new issuance collapsed to just 44.1 billion yuan (US$7.1 billion), a three-year low and a fraction of the 12-month average of 233.5 billion yuan. Corporate bond yields were still sharply higher than two months earlier, before the liquidity squeeze began.

The most interesting takeaway from our meetings was the expectation by clients of depreciation of the yuan in the third quarter and during the years to come. Already in May we encountered in the mainland the view that appreciation is over for the rest of the year, but by July sentiment had turned negative. This reflects anecdotal evidence of a decline in demand for trade financing, weak readings of the manufacturing PMI new export orders index and a contraction of exports in June in year-on-year terms.

Latest data for China’s external position suggests that capital has already started to leave the country. However, given China’s vast foreign exchange reserves and current account surplus, as well as policy preference for a long-term rising trend needed to reduce the reliance on exports and internationalize the yuan, we still expect very gradual gains in the years to come.

As the second quarter brought mounting evidence of a slowdown, it became apparent that the economy cannot meet the government’s 7.5 percent growth goal on its own. We estimate that without policy support, this year’s growth would slow to 7.3 percent.

Indeed, in recent weeks key officials have reiterated the 7.5 percent goal for 2013 and their confidence that it will be achieved. Having confirmed the target, policymakers began to roll out stimulus measures modelled on the 2012 recovery plan.

They have been and will continue to be small because of the narrow gap between what is possible without government aid and the goal, and because large-scale stimulus would be socially unpopular. For the latter reason, the government will not make much effort to publicize the stimulus widely, and therefore its impact on sentiment will be more muted until results show up in the data.

Old playbook

It is remarkable to see how similar this year’s measures have been to what we saw last year. Clearly, policymakers are using the same old playbook to micro-manage the economic cycle. In particular, so far this year the People’s Bank of China has already halted yuan gains to help exporters, opened the door further to capital inflows (through an increase of the QFII quota), and liberalized lending rates, and resumed adding liquidity through reverse repos to lower financing costs. In the fourth quarter, we see a 50-basis-point cut in the reserve requirement ratio due to a tightening of liquidity toward the year end.

However, this is not enough to let policymakers sleep with ease, because the possibility of downside risks to growth (external and internal) are materializing calls for a cushion. Therefore, we expect additional steps. Market-based steps, such as improvement in financing conditions, are not fool-proof, because there may not be enough demand to take up cheaper loans. Specifically, we expect a detailed plan to add to infrastructure spending, in particular through railway construction. The media already reported such intentions, suggesting a 40 billion yuan boost to planned capital spending on railways — exactly the same tactics as we saw in the summer of last year.

Dariusz Kowalczyk is a senior economist and Gary Yau a research associate at Credit Agricole. The opinions expressed are their own.

 

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