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Slow growth to spur policy response
By Stephen Green, Li Wei and Shen Lan |
June 20, 2013, Thursday
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Print Edition
Print Edition
WE spent a few days in Beijing recently, and found growing concern about the short-term momentum of the economy and a lack of confidence in the outlook: the outlook is pretty smoggy.
There are some bright spots, but folk seem to be focusing on poor export growth, the deceleration in light manufacturing production, and an apparent reversal of the manufacturing inventory cycle. Also, there are sharply higher rates in the interbank market and few signs that the expansion of shadow credit is slowing. The European Union Chamber of Commerce in China's annual membership survey was published in May and reflects some of the renewed concern.
We still believe that the housing market recovery, a pick-up in project approvals, recovering profitability, supportive credit conditions and stronger exports will support moderately stronger growth in the second half. But, if we are honest, we must also recognize that the outlook is clouded right now.
Premier Li Keqiang has, of course, started his term attempting to focus on the structural problems in the economy. Easing monetary conditions would not help this agenda, as they would inflate housing prices and let local governments further expand their off-balance sheet debts. However, this view is not quite accurate: Beijing kept policy tight in 2008, all the way into September, even as external demand was disappearing. The lesson is that while Premier Li's intention to accept weaker growth may be stronger, he will have to respond if there are clear signs of a severely weakening economy.
Sharper slowdown
A prominent op-ed in the China Securities Journal argued recently that the risk of a sharper slowdown had increased with the weak May data. It pointed out that a lot of the cash corporates are earning right now is going into debt repayment. It also noted that with the end of US QE in sight, funds are leaving emerging markets, and possibly also China. The op-ed concluded as follows:
"Policymakers appear focused on ensuring financial stability, maintaining firms' current level of debt burden, preventing a cash crunch in the corporate sector. If a rate cut can cut firms' debt burden, or reducing the reserve requirement can help maintain relatively supportive monetary conditions, then in the second half, objectively speaking, there exists the possibility of interest rate and reserve requirement ratio cut(s). But whether to cut or not is a very difficult choice; it will test the policymakers' ability to bear a slowdown. A slowdown is a pretty good time to deal with overcapacity and improve the economic structure. So if the economy is still growing at 7.5 percent or 7 percent and that is acceptable, and the jobs market does not get hit, then policy might remain on hold."
A debate about policy has clearly begun. The decision is not only data-dependent, but leader-dependent, too. We note that our Monetary Conditions Index for China is in neutral territory; there has been an 8 percent strengthening of the nominal effective exchange rate this year, but at the same time, social financing credit growth has accelerated (22 percent year-on-year in May) and is now at 200 percent of GDP.
One contact who used to work in central government is hoping for a rate cut in July. Whether he gets it depends on how bad the second-quarter data is, he argues. If the second-quarter year-on-year GDP print is nearer 7 percent than 7.5 percent, he thinks that they would cut. We raised our doubts about how effective such a move would be, given credit growth and the fact lending rates are falling in the interbank market.
Private sector
Our contact argued that the private sector was still suffering from relatively high interest rates. But we suspect that these rates will not be much affected by a 25-basis-point or 50-basis-point cut by the Chinese central bank.
However, given the slow pace of recovery and the still-moderate level of food price inflation, we are revising down our CPI inflation calls to 2.8 percent from 3.2 percent for 2013, and to 4.1 percent from 4.7 percent for 2014.
We think that the central bank will be able to raise benchmark rates when CPI inflation hits 4 percent, which we had scheduled in for the fourth quarter of 2012. We now see 4 percent being breached on the upside in early 2014, and so move the start of the next rate hiking cycle into the first quarter of 2014.
We still forecast three 25-basis-point rate hikes - one in the first quarter of 2014 and two in the second quarter of 2014. It is also possible that the central bank will integrate this tightening with another move to liberalize interest rates.
The next step would be to raise the ceiling on deposit rates (from 10 percent on top of the benchmark to 20 percent, for instance). The effect of this would be higher deposit rates given the deposit hunger most banks are feeling right now. The central bank may also further lower the floor on lending rates, but this would have a much smaller impact, given that banks are lending mostly at or just below the benchmark, rather than at the 30 percent boundary.
There are some bright spots, but folk seem to be focusing on poor export growth, the deceleration in light manufacturing production, and an apparent reversal of the manufacturing inventory cycle. Also, there are sharply higher rates in the interbank market and few signs that the expansion of shadow credit is slowing. The European Union Chamber of Commerce in China's annual membership survey was published in May and reflects some of the renewed concern.
We still believe that the housing market recovery, a pick-up in project approvals, recovering profitability, supportive credit conditions and stronger exports will support moderately stronger growth in the second half. But, if we are honest, we must also recognize that the outlook is clouded right now.
Premier Li Keqiang has, of course, started his term attempting to focus on the structural problems in the economy. Easing monetary conditions would not help this agenda, as they would inflate housing prices and let local governments further expand their off-balance sheet debts. However, this view is not quite accurate: Beijing kept policy tight in 2008, all the way into September, even as external demand was disappearing. The lesson is that while Premier Li's intention to accept weaker growth may be stronger, he will have to respond if there are clear signs of a severely weakening economy.
Sharper slowdown
A prominent op-ed in the China Securities Journal argued recently that the risk of a sharper slowdown had increased with the weak May data. It pointed out that a lot of the cash corporates are earning right now is going into debt repayment. It also noted that with the end of US QE in sight, funds are leaving emerging markets, and possibly also China. The op-ed concluded as follows:
"Policymakers appear focused on ensuring financial stability, maintaining firms' current level of debt burden, preventing a cash crunch in the corporate sector. If a rate cut can cut firms' debt burden, or reducing the reserve requirement can help maintain relatively supportive monetary conditions, then in the second half, objectively speaking, there exists the possibility of interest rate and reserve requirement ratio cut(s). But whether to cut or not is a very difficult choice; it will test the policymakers' ability to bear a slowdown. A slowdown is a pretty good time to deal with overcapacity and improve the economic structure. So if the economy is still growing at 7.5 percent or 7 percent and that is acceptable, and the jobs market does not get hit, then policy might remain on hold."
A debate about policy has clearly begun. The decision is not only data-dependent, but leader-dependent, too. We note that our Monetary Conditions Index for China is in neutral territory; there has been an 8 percent strengthening of the nominal effective exchange rate this year, but at the same time, social financing credit growth has accelerated (22 percent year-on-year in May) and is now at 200 percent of GDP.
One contact who used to work in central government is hoping for a rate cut in July. Whether he gets it depends on how bad the second-quarter data is, he argues. If the second-quarter year-on-year GDP print is nearer 7 percent than 7.5 percent, he thinks that they would cut. We raised our doubts about how effective such a move would be, given credit growth and the fact lending rates are falling in the interbank market.
Private sector
Our contact argued that the private sector was still suffering from relatively high interest rates. But we suspect that these rates will not be much affected by a 25-basis-point or 50-basis-point cut by the Chinese central bank.
However, given the slow pace of recovery and the still-moderate level of food price inflation, we are revising down our CPI inflation calls to 2.8 percent from 3.2 percent for 2013, and to 4.1 percent from 4.7 percent for 2014.
We think that the central bank will be able to raise benchmark rates when CPI inflation hits 4 percent, which we had scheduled in for the fourth quarter of 2012. We now see 4 percent being breached on the upside in early 2014, and so move the start of the next rate hiking cycle into the first quarter of 2014.
We still forecast three 25-basis-point rate hikes - one in the first quarter of 2014 and two in the second quarter of 2014. It is also possible that the central bank will integrate this tightening with another move to liberalize interest rates.
The next step would be to raise the ceiling on deposit rates (from 10 percent on top of the benchmark to 20 percent, for instance). The effect of this would be higher deposit rates given the deposit hunger most banks are feeling right now. The central bank may also further lower the floor on lending rates, but this would have a much smaller impact, given that banks are lending mostly at or just below the benchmark, rather than at the 30 percent boundary.
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