Economy Report

By Andrew Smith

We have been suggesting that stimulus measures from the PBOC could be put into action to stimulate the ailing economy for some time now. Finally our prediction has come to fruition, with the central bank stepping to encourage lending by lowering the Reserve Requirement Ratio (RRR). On4 February 2015 the PBOC announced that they were reduced the amount of capital banks were require to have on hand in order to encourage more lending. It has been estimated that the move to loosen up the credit markets could lead to up to 100 billion USD of extra capital being injected into the economy through extra borrowing.

The move comes at a time when policymakers also face the dilemma of needing to stimulate a slowing economy whilst also sorting out the increasingly dire debt situation. According to a recent report by the McKinsey Global Institute, China's overall debt load is now creeping towards 300 percent of GDP. This includes the total amount of borrowing by banks, local and central governments, corporations and private lenders. To say that this is a headache for Chinese policymakers is a gross understatement. It places them in the incredibly uncomfortable position of having to choose between lending to spur on economic growth and taking control of the debt burden.

The Institute identified three key conclusions that were of particular concern:

About half the debt of households, non-financial firms and government is either directly or indirectly linked to real estate.

Rapid growth in lending by local governments, "many of which may not be able to repay"

Around a third of total outstanding debt in China is provided by a highly opaque shadow banking system, made up of various forms of non-bank lending.

The reporter's authors also went on to write that "A plausible concern is that the combination of an overextended property sector and unsustainable finances of local governments could result in a wave of loan defaults in China, damaging the regular banking system and potentially creating a wave of losses for investors and companies that have put money into shadow banking vehicles".

Whether or not that has a profound enough effect on the broader economic growth remains to be seen, but analysts are suspecting that this latest move is only the start of a major plan to stimulate growth through monetary policy. Mark Williams, chief Asia economist at Capital Economics, has claimed that "As things stand, alongside further reserve requirement ratio cuts in coming months, we continue also to expect benchmark interest rates to be cut further -- perhaps twice more by the middle of this year". He went on to say that "That could change though if today's move ignites another equity market surge".

One also has to wonder whether or not the government will make any moves on the fiscal side to help offset slowing GDP growth. Last year we saw a wave of reforms and a number of things like tax incentives being given to small businesses that were supposed to get the economy moving a bit faster; particular in terms of consumer demand. Obviously a more direct intervention through investment in infrastructural projects, which have traditionally been a major growth promoting tactic, are not a preferable course of action at the moment but they can't be ruled out altogether if the slowdown continues.

It is easy to understand why the Chinese authorities have taken this step. The economic fundamentals have been deteriorating for some and if the latest data is anything to go by, it doesn't look like the situation is going to improve any time soon. Figures released in early February indicate that exports were up 3.3 percent from the following year, a much slower growth rate than analysts and policymakers had expected. That isn't all too surprising though given the persistent, if not deteriorating weakness we are seeing in key export markets like the Eurozone. It could also be a consequence of a recovery in the yuan's valuation, in line with the recent appreciation in the dollar. HSBC's PMI data for January also got everyone's attention. The figures showed a reading of 49.7 percent, which indicates a slight contraction in overall factory output. Although the country's leadership is trying to move China away from an overreliance on the manufacturing sector, this remains one of the cornerstone aspects of the economy and is therefore a slowdown in this area is a major cause for concern.

Import data however was perhaps the most worrying of all. The data for January showed that imports had dropped by a staggering 19.9 percent year on year. Although almost everyone expected a steep decline, this figure was much worse than expected. Reuters' Shanghai-based reporter Pete Sweeney points out that this trend "is worrisome even after accounting for cyclical factors; last year the new year holiday idled factories and financial markets for a week in January, but this year the holiday comes in late February and January was a full month of business as usual". On the brighter side, at least inflation is still expected to stay low, despite the recent easing measures and the likely price surge that will come about around the Spring Festival. Like their European counterparts, some Chinese economists are even talking about the possibility of deflation, although it still looks like rather unlikely outcome in China any time soon.

Going forward it is hard to predict the next policy step or what kind of growth we are likely to see. The easing of credit may provide a temporary relief for institutions that have been hit hard by the Xi administration's drive to rein in loose money and strategically burst asset bubbles before they get any more out of hand. We will have to wait and see whether the PBOC takes further steps to stimulate growth. With everything that is going on the last thing they need is major financial catastrophe in Europe, so it goes without saying that they will be keeping a close eye on the Greek debt situation. On the domestic front it is now clearer than ever before that the economic transformation has to happen sooner rather than later.

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