So far China’s new leadership has resisted short-term fixes to the country’s slower growth and held true to the need for deeper structural reforms to rebalance the economy. The latest measure of economic activity — HSBC’s flash purchasing managers’ index for May — may test their resolve, but not, this Bystander hazards, break it.
The May reading, at 49.6, down from April’s 50.4, was the lowest in seven months. More germanely, it fell below the 50 mark that delineates expansion from contraction. The modest expansion of manufacturing activity that has been seen since the slowing economy started to pick up steam again last autumn has been replaced by modest contraction. The second area of concern is that the weakness seen by China’s manufacturers in global demand for their goods and services seems to have spread to their domestic customers.
The difficulty for policymakers is that they have limited scope even for short-term fixes. Monetary policy is already easy and loosening it further or splashing out on another round of government funded infrastructure investment spending risks further inflating property bubbles and an already concerning local government debt overhang. At best there is likely to be spot stimulus measures applied where local employment conditions put social stability at risk.
One of the vehicles for this might be the new leadership’s urbanization plans, a centerpiece of its long-term management of moving China to a slower growth trajectory than the double digit annual growth it averaged over the past three decades. While the plan will take years to implement, it could set a tone for structural reform that would have a more immediate effect on economic confidence, and prevent GDP growth for the year falling below 2012′s 7.8%, its slowest in more than a decade.
Economic activity remains weak in China. April’s industrial output was up 9.3% in April from March’s 8.9%, a seven-month low, but short of expectations of 9.5% growth. The recovery that started in the second half of last year is not gathering any momentum. Second-quarter growth is on track to be little better than the first quarter’s 7.7%, and likely less than 8%.
That is testing policymakers’ patience. They would like to stimulate short-term growth, but are already running loose monetary policy. Any further loosening risks pushing up consumer prices and further inflating asset bubbles, particularly property prices. Meanwhile, state-led infrastructure construction spending, which has been a big driver of growth since the 2008 global financial crisis, is running out of steam and effectiveness, and the debt overhang, as much as 20 trillion yuan ($3.25 trillion), is a worry in Beijing.
The temptation, particularly for provincial and local officials, is to fall back on the tried and trusted remedy to provide a short-term boost to growth, but that also delays the necessary long-term rebalancing of the economy to which the new leadership repeatedly says it is committed. For now, policy makers are likely to stay their course, but they badly need some growth to steady their nerves. With the global economy sluggish, that is more out of their hands than they would like.
China’s economy grew more slowly in the first quarter of this year than it did in the fourth quarter of last — 7.7% year on year against 7.9%. The consensus among economists had been that the recovery from last year’s slowdown would continue into the first quarter, albeit modestly, but not ease back.
It was industrial production that was the weak spot. Fixed asset and real estate investment both ran at 20% above the same quarter the previous year. Absent the weakness in industrial output, that might have tempted policy makers to tighten monetary policy to cool off the property market. This Bystander would now expect the central bank to hold fire on that while it sees if the recovery picks up again in the second quarter.
This Bystander is not as surprised as some to see the December HSBC Purchasing Managers’ Index for December showing further expansion of China’s economy. Infrastructure spending and cautiously easier monetary policy have been visibly kicking in since September.
The final reading of the December HSBC PMI was 51.5, compared to a preliminary reading mid-month of 50.9 and November’s 50.5. A reading above 50 indicates expansion. Domestic demand is making up for sluggish overseas markets; the new export orders sub-index for December fell to 49.2 from November’s 52.1. That manufacturing is growing at its fastest pace since May 2011–and the official PMI due tomorrow will tell much the same story–will give policymakers in Beijing good reason to believe that the momentum of an accelerating pace of expansion can be carried into 2013.
How far and how fast will they let it run? The People’s Bank of China on Saturday flagged the risk of defaults in the shadow banking system. Inflation, a persistent concern, is beginning to edge up again. If either concern is present beyond the first quarter of 2013, some tightening is likely to start.
China’s annual two-day closed door economic policy-setting conference has concluded with a cautious weather eye again being cast to the squalls of the global economy next year. Policy will be kept as is, not unexpectedly, but with room for maneuver in both fiscal and monetary policy reserved should the global economy deteriorate.
Rising protectionism, inflation and asset bubbles are listed as the main risks along with the longer running lack of demand in China’s export markets in the rich countries. Beijing will target 7.5% GDP growth for 2013, the same as this year. Monetary policy will remain modestly expansive, with a hand being kept on the bank lending and public spending taps ready to open or close them a turn as necessary. Property controls will remain and the yuan held steady.
The conference seems to have said all the right things about economic reform. The country will push forward with the next stage of economic reforms “with greater political courage and wisdom,” state media reported. That, though, is more difficult to deliver than economic targets.
Central bankers are not noted as being wide-eyed optimists at the best of times. China’s are living up to the stereotype. The world’s investors are regaining some of their animal spirits on the strength of new signs that the slowdown in China’s economy is at last ending, but China’s central bankers are striking an ultra-cautious note in their third-quarter monetary policy report.
They warn that global demand could slump again unless the crisis in the euro zone is sorted out, sending the world into a double-dip recession. As for China’s part of the world economy, ‘the foundation of an economic recovery is not yet solid”. The People’s Bank of China’s policy focus will emphasize growth, but monetary policy will remain “prudent”.
The central bank fears that measures to promote domestic consumption are potential inflationary, even though inflation is subdued despite rising energy prices and labour costs. Year-on-year consumer price inflation was 1.9% in September, down from 2% the previous month.
No mention of further cuts in interest rates or banks’ reserve requirements. Playing with the short-term liquidity taps, as was done with the $60 billion injection into the money markets earlier this week, is the sort of open-market operation the central bank now prefers to “fine-tune” the economy, regardless of the risk of more volatile short-term interest rates. It is a way to talk tight but act loose, and still be able to switch back to acting tight at short notice.
Consumer price inflation ticked down again in September, being 1.9% year-on-year, down from August’s 2%. That was much as expected and leaves inflation running well below the official target for the year of 4%. Officials have been signaling 2.7% as the likely number for the full year.
That would still appear to leave policymakers plenty of headroom for further easing of monetary policy, should they choose to use it. The central bank has cut interest rates twice since June and lowered banks’ required reserves three times since November. Yet its main way to pump up sagging growth has been to open the liquidity taps. The broad measure of the money supply, M2, grew by 14.8% in September, its most rapid monthly expansion since June last year, and above the central bank’s 14% target number for the year.
However, the liquidity taps have been opened cautiously and with some trepidation by the central bank. Zhou Xiaochuan, governor of the People’s Bank of China, writing in the latest edition of the Journal of Financial Research, a house organ of the bank’s, is talking of closer to home when he warns of the inflationary risks in the efforts around the world to shore up the sluggish global economy by easing monetary policies. He encouraged central bankers to be ready to start mopping up operations.
At home, property prices are resurging, propelled by the increase in liquidity. Policymakers have fought a two-year-long battle to deflate the property bubble without bringing down the whole house of cards. They will not readily throw that hard-won victory to the winds. With third-quarter GDP growth figures due on Thursday, we’ll get a sighting of how much of the headroom that falling inflation has provided, the central bank has a taste for.
July’s monthly economic indicators now starting to be published show clearly that the hoped-for bottoming of China’s growth slowdown has yet to materialize. Both industrial output and retail sales growth slowed in the month, to 9.2% from 9.5% and to 13.1% from 13.7% respectively. That will add to the pressure on policymakers to increase the stimulative measures they have been taking. The fall in inflation to a 30-month low at 1.8% year-on-year gives them more headroom to do so.
Update: the unexpectedly slight 1% increase in exports in July is further evidence.
This Bystander’s first take on China’s surprise cut in interest rates, its second in barely a month, is that the second-quarter GDP number due to be released next week will be below expectations. The consensus view of private economists is that the economy grew by 7.5% between April and June, down from the first quarter’s 8.1%. That would represent a sixth consecutive quarter of slowing growth, and be the slowest quarter since the immediate aftermath of the 2008 global financial crisis.
The People’s Bank of China has cut its benchmark one-year lending rate by 31 basis points to 6% and the deposit rate by 25 basis points to 3%, both effective from Friday. Banks will also be allowed to increase the discount they can offer on their loan rates to 30% from 20%, a twin effort to stimulate more demand for credit and liberalize interest rates a tad further.
The reduction in consumer price inflation from last year’s peak leaves headroom for more monetary easing, rate cuts and reductions in banks’ capital reserve requirements should the anticipated bottoming out of the growth slowdown not occur during the second half.