Monthly Economy Report

By Andrew Smith

The main point to take away from the most recent data is that the economic slowdown in China is gaining momentum. That isn't to say that we are heading for disaster, indeed the economy is still outgrowing all the other major economies on the planet – with annual GDP growth looking set to fall between 6.5 and 7%. What it does mean, however, is that there is a serious correction and a much needed rebalancing taking place.

As analysts expected, imports continued to fall in May for a seventh straight month. According to recent data from the Chinese Customs Department, imports fell by 17.6% from the previous year to 131 billion USD. A poll of leading economists by Bloomberg estimated a median decline of around 10%, so the official figures coming out of the Middle Kingdom are surprising and disappointing in equal measure. Zhu Haibin, a Chinese economist who works for JP Morgan, told Reuters news agency that, "Imports are still much weaker than expected. Exports are doing fine, even though we are still talking about a year-on-year decline, but in terms of momentum they've rebounded a bit after the collapse in March. This year the government set up the target of trade growth at 6%, which at this moment, is still impossible to achieve, particularly with the weak imports."

Exports did also decline, albeit at a lower rate than many analysts had been forecasting. The aforementioned Bloomberg poll suggested that they would fall by around 4% year on year. However, they came in at around a 2.5%, with the total value of Chinese exports standing at 190 billion USD. HSBC's Purchasing Managers' Index (PMI), which tracks activity in factories and workshops and is seen as an important barometer of economic health, contracted for the third straight month in May and economists expect the shrinkage to extend into the middle of the year.

The government has warned that the manufacturing industry still faces multiple challenges, even as China's official PMI hit a six-month high in May. Experts have cited the usual list of reasons why exports have continued to fall. The main one is of course the weak external demand, particularly from Europe and North America. The U.S. economy remains on shaky ground, while the situation in Europe could get a whole lot worse if policymakers don't find a way to solve the Greek debt crisis. On top of all that there has been a strengthening of the Chinese CNY which has led to a slowdown in exports as a result of higher prices.

We also learned that gross domestic product (GDP) growth came in at around 7% between January and March. If this were to continue over the last three quarters of the financial year it would be in line with the government's official target. High level officials, including President Xi Jinping and Premier Li Keqiang, have repeatedly stated that they are willing to accept steadier growth if it is a result of positive structural reforms and other considerations such as environmental protection.

Having said that, it doesn't mean that Beijing is willing to stand back and let the economic growth falter altogether. Last month we reported that the People's Bank of China had lowered interest rates again in order to spur lending and ultimately, it is hoped, give the economy a boost at a time when the fundamentals are looking less healthy than they have for a long time. The move came after a Politburo spokesperson said that the central authorities need to, "more efficiently channel monetary policy in order to support the real economy." Analysts are expecting the latest round of easing measures to come into effect over the next quarter, which may indeed boost growth or at least keep it on track to hit the government's 7% target for 2015.

There is still a great deal of debate about whether there will be a further rate cut this year. Although key sectors such as exports and construction have taken a hit in recent months, the credit situation is giving policymakers less scope to stimulate the economy like they have in the past. An article in the Wall Street Journal recently pointed out that, "Bad loans are rising in China's vast banking system. According to the China Banking Regulatory Commission, nonperforming loans surged 140 billion CNY (22.6 billion USD) from the beginning of the year to 982.5 billion CNY as of March 31, the biggest quarterly jump in more than a decade."

Moreover, it suggested that, "Dud loans made up 1.39% of all loans as of the end of March, up a 0.14 percentage point from the end of 2014, representing the highest level in five years. The rise of bad loans is damaging banks' profits at a time when they are being called upon to make credit more accessible. China's top five state-owned banks, for instance, saw their first-quarter profit grow less than 2%, compared with the double-digit growth rate typically seen in previous years". In response to the dire debt situation there has been a lot of talk about credit easing measures that would essentially allow local governments to restructure their debts and make them more manageable. We will have to see what happens in this key area.

The places that haven't been feeling the pinch though are the equity markets. Despite a few bumps in the road, the raging bull market has continued to charge forward at an incredible pace as investors transition from real estate to stocks. Over the last 12 months the market has created over USD6.5 trillion– enough to buy Apple Inc. eight times over. Bloomberg analyst Kyoungwha Kim has pointed out that, "Mainland speculators have borrowed a record 348 billion USD to bet on further gains, novice investors are piling into shares at an unprecedented pace and price-to-earnings ratios have climbed to the highest levels in five years."

While it has made plenty of money for plenty of people so far, the general consensus amongst the experts is that the current situation is a classic bubble that in many ways resembles the great crash of 1929. Michael Every, the head of financial markets at Rabobank International in Hong Kong, summed up the mood when he said, "Of course, there's short-term money to be made. But I fear it will not end well. We have a wonderful bubble on our hands."

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