On Friday Bloomberg ran a rather up-beat piece by Kevin Hamlin suggesting that China might be the first major economy to recover from the global economic slump given that its fiscal stimulus and credit boost would support domestic demand. This is the latest in a series of more optimistic pieces that have been appearing in recent weeks on Chinese economic outlook prompted in part by recent data (PMIs, credit and money growth) which suggests that the pace of economic deterioration in China is now slowing.
It seems too soon to suggest that China will be able to recover before there is some expansion in the global economy- particularly as China also faces a domestic slowdown which has impaired investment and it is not yet clear that the new credit extension is actually finding its way into longer term projects (there is some evidence some fund are being diverted into the once-again booming equity markets). Despite the rapid credit expansion it seems much too soon to suggest that China has turned the corner – export data and electricity demand data released earlier in the week suggest some caution. Chinese exports contracted by about 17.5% y/y in January (albeit contraction was somewhat more moderate if adjusted for the new year holiday) and electricity generation (usually seen as a proxy for economic output) contracted in double digits year on year. Furthermore, over capacities still seem present. Investment remains weak and consumption seems to be faltering. All in all, China does not seem able to lead us out of the global recession – particularly as it is suffering from the toughest external environment and domestic weakness despite government funds to prop up demand. As a result, it still appears that China will find it very difficult to grow more than 5% this year (as argued in the RGE global outlook) well below trend and may have trouble getting back up to trend growth in 2010 given that global export demand will remain weak.
By contrast, the more optimistic view suggests that Chinese government spending, goaded by the domestic banks will boost investment and consumer confidence, transfers to individuals (amount unclear) will keep them spending leading to some improvement. Then if (and it is a big if) the U.S. and global economy starts to recover in H2, Chinese economic growth will reaccelerate. This hinges on two big assumptions one that Chinese investment can return to past levels and that bank lending stands in for the reinvestment of past corporate profits, that more is consumed domestically, and that the global economy recovers in that time frame. Both may be risks. Even consensus suggests China will grow only in 6% range (y/y) in the first two quarters of 2009 (or relatively little on a q/q basis). But let’s take a tour through the recent Chinese economic data. (to follow along, check out the related RGE spotlight issue Is the Chinese Economy Bottoming Out?)
The pace of deterioration of China’s manufacturing sector and value added industrial production have leveled off for now, likely because the process of destocking is underway and Chinese manufacturing could not keep worsening at the same rate. Purchasers Managing Indices (PMIs) for Manufacturing rose slightly in December and January from the record lows recorded in November. January figures from CLSA were only 42.2 (up from 41.2 in December)… a pretty dire figure and the sixth month of contraction. The figures from the Chinese federation of labor were somewhat higher, with the PMI for manufacturing rising to 45.3 in January from 41.2 in December and 38.8 in November, marking the sixth month of the last five in contraction. The index is based on surveys of 700 companies in 20 industries. New export orders rose to 33.7 in January from 30.7 in December. The output index jumped to 45.5 from 39.4. The new-order index rose to 45.0 from 37.3. While it is a good sign that the pace of deterioration has slowed, manufacturing remains in contraction and is unlikely to turn around much until external demand improves – something we see as unlikely until 2010. But this is a data point worth watching particularly the relative performance of the new export orders vs all new orders. A significant increase in all new orders would suggest a recovery in domestic demand despite the fact there continue to be a number of disincentives (export rebates, supply chains etc) to selling goods domestically. A continued upward trend in this data could indicate a partial recovery and is an upside risk factor to the outlook described above – but with PMI still reflecting a contraction, that may take some time. The real test will come in March or April when we would expect to see factories again operating at capacity
Of more concern – if not a surprise, factories are now shedding workers at the fastest pace in the 4 year history of the index. It’s likely that some of the massive inventories are now being worked off, but it’s hard to see any real new demand, in part because pressure on exports is likely to continue and domestic demand will likely falter too (see below).
No wonder Chinese officials are suggesting that job losses among migrant workers could be as great as 20 million. Victor Shih adds this number to other reported figures of unemployed college graduates and urban residents and comes up with a total of over 37 million. That’s a lot of people despite the size of China’s population! He suggests unemployed figures could reach up to 50 million by later this year. [note I changed a couple of typos thanks to a helpful commentator] The Chinese government is taking this threat seriously and trying to redeploy at least some of its human capital, and to reduce the unemployment rate among college graduates which at about 12% is three times the national average. It announced job training program for graduates and has accelerated its efforts to send college graduates to teach in the country (a plan Minxin Pei called ‘Teach for China.
China is starting to roll out its fiscal stimulus (which was enthusiastically welcomed by the G7 this weekend) starting a variety of infrastructure projects, this will provide some support to jobs, some new demand for commodities etc. However, it may only partly offset the weakness in residential property which accounts for 20% of investment at a time when house prices and sales volumes continue to fall in most of China’s big cities. Furthermore with most investment financed by retained earnings of corporations, capital expenditure may be limited in the near term. FDI has also been on a downward trajectory. January marked the fourth consecutive year on year decline in FDI, though it averaged a greater amount than the average of recent months. One explanation for more restrained FDI outlook may be the reversal of RMB appreciation expectations – FDI was widely thought to be padded by other capital inflows.
Consumption is a major test. Retail sales were up 14% for the New Year holiday from the previous year. Sounds promising? A couple of caveats. Remember last Lunar New Year came in the midst of unprecedented winter storms that paralysed the country and shut down the rail systems and power plants. With many people stranded for the holidays sales were down. Furthermore, 14% is actually slower than the y/y monthly retail sales growth. Still, it may be a sign that the government efforts to encourage rural purchases of appliances are having some effect at least for now. Though with jobs being lost, these incentives may only go so far in supporting purchases.. The true test of consumption will come in the next few months when it becomes clearer if urban households which account for 75% of Chinese consumption maintain their consumption. So far, the evidence suggests they are buying less and that the softening of
purchases is more pronounced in urban not rural areas. Although the Chinese bought more cars than Americans did in January they bought less than they did this time last year. Consumer confidence continued to slip in January.
It’s worth noting that all of the January data (and probably some of the February data) should probably be taken with a grain of salt given the week-long holiday. Typically the data gets distorted by the holiday as many factories shut to allow workers to go home meaning this month had a shorter working period. This year, many may have shut early, and still others may not open up for some time. Furthermore even inflation data was likely influenced by the New Year effect. the jump in food prices was the main factor that kept China out of deflationary territory in January. With the high base effects of food and commodity prices several months of negative price growth are possible. Though inflation is another indicator that reflects that the deterioration of trends have been pared.
The most significant shift may have come in the lending and money growth numbers. Loan growth was up almost 19% in December y/y, a much faster pace than in recent months and attributable to government pressure on the banks to lend. Loans increased even more in January – almost 23%. This pace may not be sustainable nor is it necessarily funding investment. Firstly most of the credit extension is in short-term bills financing which was the fastest to be choked off and the first to return. Medium and long-term credit extension was only about a third of credit extended. Ken Peng of Citi notes that although such mid-term loans were a record they are less than 1/8th of the stimulus package not including local level projects which are also looking for funding. Thus the success of the stimulus will hinge on willingness of banks to shift away from short-term financing.
A significant degree of the credit extended was in the form of trade credit, the sort of loans granted when banks are wary about repayment. Furthermore these loans may not be financing new expenditure.
The rapid extension of credit poses several potential problems. 1) it may be making its way into the equity markets which are up more than 1/3 so far this year. As such the funds may be feeding another bubble. 2) some of the funds may not be extended to those less than credit worthy which might boost deliquency and default rates. So far non-performing loan ratios continue to be very low but banks may be allowed to delay significantly until they report a loan non-performing and the recent recapitalization of the ABC involved writedowns. However loan growth may add to contingent liabilities. 3) lower real wages, job losses etc may add to defaults even as it impairs disposable income. There is anecdotal evidence that some of the loans may just be a recycling of funds, in which funds are extended to corporates to make loan quotas and then are redeposited. Michael Pettis previously suggested that many loans may just be facilitating bringing items back on balance sheet. Even if this is not the case, it’s still not clear how much is getting to the small and medium sized companies that need the funds and how much the extension of funds can offset the weakness in the property markets.
China though seems determined to spend enough to stimulate the economy. New Sectoral stimulus packages are being released in most weeks. The Chinese foray back into fiscal deficit may limit spending, however, China still has limited debt so it may be able to borrow domestically – the real test will come regarding consumer spending.
Commodity prices have been undergoing a China-bounce of late, iron ore prices and even steel have come off their lows and the volumes of Chinese imports of a whole range of commodities increased slightly in December, albeit remaining much lower than their mid-2008 peaks. In price terms of course imports of commodities slumped – but the price volatility suggests focusing on volume which remains near their recent lows and may reflect that the pace of destocking has petered out. Electricity power generation was reportedly down 13% y/y in January, the third month of contraction, and much worse than the 3-4% contraction in October, and about 10% in November and December. Power demand is usually seen as a proxy for industrial output and one more reflective than GDP. So the continued weak electricity demand does not bode well. In part demand still reflects over capacities in the sector and the particular weakness of several power-hungry sectors like steel, aluminum etc.
Exports contracted by 17.5%. the steepest in 13 years and the third month of contraction. Imports continued to contract by even more, plunging by more than 43%. This is in line with the collapse in exports to China from South Korea, Japan and Taiwan. Korea’s exports to China have by even more than its overall exports. Meanwhile Citigroup notes that container throughput at Shanghai and Shenzhen, the biggest two container ports in China, slumped by 15% and 17% in Jan (y/y (be consistent)), indicating a major slump in exports/imports. They further warn that Chinese container throughput may have been inflated as companies have been reluctant to send boxes completely empty and may instead send them partly full.
With 40% of Chinese exports bound for the contracting US and EU markets and much of the remainder heading to Asian economies and ultimately bound for end users in the G3, export demand will continue to be weak. Demand from countries like Russia, Latin America and India which was on the rise, has now fallen also – Russia’s imports have contracted very sharply – as much as 40% from non-CIS countries in January – hence why they have avoided a current account deficit as yet.
Housing prices seem set to keep dropping through much of the first half and the decline in prices will weigh on the construction sector – reducing jobs and demand for raw materials. Volumes are still weak, though government incentives may be boosting transactions. In fact although the fiscal stimulus is providing a support to demand.
Capital expenditure seems apt to be weak. In China most capex is financed by retained earnings not bank loans or other financing. With most SOEs not having profit growth capex may suffer. Yet, they may have funds stored away that support spending. However, companies are increasingly cautious. Although exports make up less than 20% of GDP, a considerable amount of investment is targeted towards this sector, meaning that the still weak external demand might limit Chinese recovery,
So what does this all mean for China’s asset markets – Chinese equities have been on a run of late. They are up more than 30% this year – 38% for Shenzhen and Greater China funds (mostly HK) have attracted significant fund flows this year on the assumption that Chinese fiscal and monetary response will cushion the economy. The government might succeed in that yet, with corporate profits likely to be scaled back, equities might face another round of losses and the government’s 8% growth target seems hard to achieve.
While major moves in the RMB seem unlikely – and the G7 pressure has shifted off the RMB – continued relative economic strength could result in a return of the inflows and appreciation pressure that were the bane of Chinese officials existence in 2008. This could actually lead the Chinese to return to currency intervention to keep the currency – and support the US dollar.
What about commodities? Diesel demand has fallen and Chinese refineries are now exporting some oil products. Chinese commodity demand still remains well below the peaks but it plus the expectation of future demand sent the Baltic Dry Index shooting up, basically doubling in recent weeks before plunging again. Chinese infrastructure stimulus, destocking and production cuts could put a floor in several product prices. China may also take advantage of cheaper prices to refill its stockpiles which could also increase demand. Yet giv
en the economic outlook and that in China, demand is likely to grow at a much more subdued pace – and perhaps it will continue to do so even when the expansion starts.