The recent data releases on the Chinese economy have once again re-energized the chorus of pessimists predicting a hard landing for the “Middle Kingdom.” This is a matter of obvious importance given that China alone has in recent years contributed significantly more to global growth than the advanced economies taken together.
In July, virtually all the economic data turned fairly sharply down. The weakness was particularly evident in the area of foreign trade. Chinese exports were up by just one percent YoY in July in a dramatic drop from the 11.3 percent pace seen in June. Even import growth in July slower to an annual 4.7 percent from 6.3 percent in June.
Naturally one more of bad data does not yet constitute a trend. Moreover, the disappointing readings were to an extent deliberate as the Chinese authorities had taken pain to squeeze inflation out of the system after their massive post-2008 stimulus package gave rise to significant imbalances ranging from a rapid build-up of local government debt to regional housing bubbles.
What is striking about the latest monthly figures, however, is the fact that they seem to so completely defy the expectation of a pick-up in activity in response to deliberate policy loosening in recent months. The Chinese authorities have taken a number of steps this year to boost economic activity with improved access to credit and new project approvals. The People's Bank of China cut interest rates in June and July and has repeatedly lowered bank reserve requirements. The authorities have also overseen a gradual weakening of the renminbi vis-a-vis the dollar.
Problematically, even as banks are once again being encouraged to lend, new bank credit reached a 10-month low in July. New local currency loans totaled RMB 540.1 billion ($ 85.9 billion) in July in a marked deceleration from RMB 919.8 billion in June. Part of the problem for banks comes from a changing liquidity environment. Deposit growth last year slowed to 13 percent, a rate unprecedented in recent times. This will reduce the ability of banks to lend through conventional channels, although the shadow banking system has grown rapidly in recent years. While this may make up for some of the slackness, it will also risk creating mounting systemic risks.
But every cloud has a silver lining. Perhaps the most encouraging news about the latest Chinese data is the sustained decline in headline inflation. Consumer price inflation fell from 2.2 percent in June to 1.8 percent in July and producer prices actually fell by 2.9 percent. This will make it much easier for the authorities to redouble their efforts to stimulate the economy. Significant steps are likely, not least because China is preparing for a leadership transition this autumn. It is now highly likely that the coming months will see continued monetary easing and signs are mounting that more fiscal stimulus is one its way. The Ministry of Finance announced that government spending in July was up 37 percent YoY while revenues only rose 8.2 percent.
These steps should help China counter some of the weaknesses caused by the global economic uncertainty. The economic woes of the West are clearly a key factor behind China's weaker trade data. Exports to the EU actually fell by an annual 16.2 percent in July. Exports to the US slowed to 0.6 percent, down sharply on 10.6 percent in June. But the data increasingly suggests that China's challenges go beyond these exogenous shocks. The rebalancing of the economy toward domestic consumption is proving slow and there are signs that the government will struggle to meet their growth targets — which currently stand at 7.5 percent — without significant interventions.
The historically slow second quarter growth of 7.6 percent was above all due to increases in investment, not least government-sponsored infrastructure projects. While the ability of the authorities, with their massive resources, to boost growth is in little doubt, there are justifiable worries that this will increasingly have to involve potentially economically inefficient and distorting measures.
With the prospect of China once again turning on the tap of government spending and credit, the overall global policy bias is taking an ever more obvious turn toward loosening. Depending on the strength, breadth, and degree of coordination of these measures, they may improve the prospects for the financial markets and quite possible for the GCC treasuries to the extent that the oil price benefits. But at the same time, they highlight an increasingly uncomfortable reality for China and the wider world alike. Global growth remains critically reliant on artificial support measures. The necessary structural reforms to stimulate production and innovation are lagging and their urgency to a degree further reduced by the recourse to stimulus. Ultimately, however, they, rather than any amount of stimulus, are the only recipes for sustainable growth.
— Jarmo T. Kotilaine, chief economist,
The National Commercial Bank.
