China’s authorities stick to their 7% growth estimates. But their actions belie their words, as they continue to loosen policy in an attempt to stimulate economic activity and prop up the domestic stock market. To date, there is little evidence that their measures are succeeding. Chinese equities remain volatile and domestic demand appears to be deteriorating. Indeed, our own measure of economic activity (our CMI) suggests that China’s growth could be as low as 3.0%. Policy loosening will go further – much further than markets are currently pricing in.
The recent reductions in China’s official rates of interest and reserve ratio requirement were merely the latest policy manoeuvres in a long line which have failed to quell concerns over the health of China’s economy. This is evident in the country’s still volatile stock markets, which resumed their descent just days later, as investors were spooked by a weak Manufacturing PMI for August.
Even though stocks are believed to comprise less than 15% of household assets, to the degree that such a drastic correction hits consumer confidence, and with it consumption, this runs counter to China’s ambition. In other words, this volatility serves as yet another impediment on China’s long road to adopting a more consumer-led economic growth model.
Indeed, we find very little evidence to suggest that China is successfully transitioning away from investment and export-led growth toward consumption. Instead, multiple alternative measures of Chinese consumer demand have deteriorated, and investment still accounts for the bulk of Chinese GDP — at just below 50%.
This week’s trade data confirmed China’s loss of appetite, with the value of its imports plunging 14.3% in the twelve months to August in renminbi terms. Exports also fell, but by less than imports, resulting in an improvement in China’s trade surplus between July and August.
July’s CMI falls to 3.0%
Our own measure of China’s economic activity (our China Momentum Indicator) fell further in July, suggesting that China’s economic growth could now be as low as 3.0%. Until late 2013, our measure tracked that reported by China’s National Bureau of Statistics. The two now diverge wildly. The same is true of China’s own indicators, with a wedge between China’s official PMI data for the non-manufacturing sector and that of overall economic growth having opened up.
In a bid to gauge China’s underlying economic activity, our China Momentum Indicator combines nominal bank lending, rail freight volumes and electricity production. While nominal bank lending has remained remarkably robust, the other components (rail freight and electricity production) have deteriorated markedly since end 2013 — when the divergence between the measures first materialised.
The latest data reveal that both electricity production and railway freight volumes contracted in the 12 months to July, down 2.0% and 11.0% respectively. Meanwhile, nominal bank lending growth firmed, up 15.7% in the 12 months to July and the largest annual percentage increase since late 2012.
The quickening in bank lending growth is perhaps unsurprising, with banks having been instructed to lend to local government projects, and encouraged to do so through repeated reserve ratio requirement cuts. But, despite this heavy-handed intervention, bank lending growth remains insufficient to offset the reduction in shadow-based financing. Accordingly, the amount of monthly net new credit supplied to the economy (as measured by total social financing) has come off its peak.
With the Chinese economy having exhausted its ability to effectively utilise credit, the rising stock (albeit at a slower pace) of total social financing remains a concern. It is unlikely to secure higher average living standards for China’s citizens, and is at risk of aggravating China’s non-performing loan ratio. In a bid to kick-start the economy, China is at risk of perpetuating its already deep-seated problems.
Further to fall
In summary, the Chinese authorities’ inability to calm financial markets, combined with their disorderly depreciation of the renminbi, has shattered investors’ faith in the Communist Party’s competence. Without favour, gaining policy traction is likely to prove that much harder. And thus far, their approach has proved insufficient to combat China’s mounting economic woes.
Accordingly, as China’s policymakers continue to grapple with the slowing economy, we expect the policy response to be ratcheted up. Both the renminbi and the benchmark interest rate have further to fall from here. And by the end of next year, we expect China to have joined the zero-interest rate club. Both the US and UK started off slowly too — at first!
