China Economic Highlights
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17 Jun. 2014
The China Weekly: Your “Eyes and Ears” on Important Economic News of the Week
Rating for MNC’s: NEGATIVE
Stimulus is adding up – but economy not really improving
China’s recent incremental easing measures across monetary, fiscal and administrative policies are starting to add up. Barely a day has gone by over the past three weeks where some targeted support measure for the economy has not been announced or expanded. The measures are beginning to put a temporary floor under the growth slowdown, and in some parts of the economy sequential growth has stabilized over the past two months. Still, despite some tentative signs of improvement, on balance the economy remains weak, with continued deterioration in as many or more sectors than those showing stabilization. It’s clear that the leadership has become increasingly uncomfortable with the pace of the economic slowdown and is shifting its focus more decisively toward growth support, causing some analysts to proclaim an imminent rebound. But don’t be fooled by the chatter – what improvement has occurred remains small in magnitude, likely temporary, and confined to narrow slivers of the economy. The rhetoric seems to over-sell what is actually occurring. We continue to expect y-o-y GDP growth to slow in Q2 and Q3 before improving in Q4 of this year.
Gradual accumulation of easing measures
On June 6th, Li Keqiang reportedly held a meeting with the leaders of eight provinces where he spoke strongly about the need for provincial leaders to do more to support growth and implement reform. On the latter point, “reform implementation” appears to mostly include the reduction of administrative red tape in project approval – indicating that implementation of even the simplest of measures is receiving pushback at the local level. More strikingly, the Premier stated that the government’s 7.5 percent economic growth target was legally binding since it had been ratified by the National People’s Congress – seemingly putting to rest any notion that the GDP target has lost importance as a performance metric or that it will be subordinated to the economic reform agenda.
Beyond Premier Li’s castigating of local leaders, more concrete measures of policy easing last week included the PBoC’s announcements both of explicit support to provide cheaper financing to exporters and of the details in regard to the central bank’s most recent cut to some banks’ reserve requirement ratio (RRR). Banks that will be covered by the RRR cut, which went into effect today (June 16th), include two-thirds of city commercial banks, 80 percent of non-county-level rural commercial banks (county-level banks already saw a RRR cut in recent weeks), and 90 percent of non-county-level rural cooperative banks. The cut was ostensibly designed to free up liquidity for loans focused on the agricultural sector and smaller enterprises, while the overall credit environment remains relatively constrained – thus attempting to slow financing to troubled sectors, such as real estate and overcapacity industrial enterprises.
In a similar move, the China Banking Regulatory Commission (CBRC) recently announced that it will begin to review the method by which it calculates banks’ loan-to-deposit ratios (LDRs). By law, Chinese banks are required to maintain a 75 percent LDR or lower, but the CBRC may begin to exclude certain types of loans from the LDR calculation, especially for smaller banks that lend to smaller, more credit-restrained entities – in effect lowering the LDR through the back door.
As far as administrative policy is concerned, several cities have begun to relax restrictions on housing purchases. For example, in Shenyang, in Liaoning province, families were previously only allowed to buy two apartments within the second ring road, but local authorities have begun to permit purchases of four apartments. Moreover, while it may not be official government policy, per se, real estate developers in several cities across the nation have gone a step further by actively supporting purchasers through reduced down payments – often to zero. These developers have begun skirting the legally required 30 percent minimum down payment requirement for first time home buyers, often by issuing these payments themselves on behalf of customers.
This type of informal credit loosening recalls the overly relaxed credit standards that underwriters employed in the United States as the property bubble inflated there. Still, there are key differences in that these practices seem – at present – to be sporadic, rather than ubiquitous, and designed to coax buyers into a cooling market rather than lowering barriers to entry in order to further fuel an already hot property market (as was the case in the US). We expect more loosening measures to be rolled out on a city-by-city basis over the coming months. However, we maintain that the high stock of inventories, especially in third- and fourth-tier cities, combined with the broader tightening in overall credit conditions and an increasingly entrenched expectation among buyers that prices should continue to fall in the near term will induce deeper price declines for housing as developers attempt to obtain cash by offloading inventory.
The third front on which policy has been eased in recent weeks includes stepped-up fiscal spending in areas such as railways, highways, waterways and aviation. On Wednesday, the State Council issued a notice after its most recent meeting stating that it will increase spending in each of these areas while also cutting the tax burden for utilities companies. Specifically, water treatment plants and small hydroelectric facilities will only be required to pay a three percent value added tax (down from a variable three to six percent range previously).
Each of these measures would individually seem to do little to aid economic activity, but as a group it’s clear that a definitive easing program is underway. And in some sense it seems to be working. The latest economic data shows that industrial activity has maintained its improved sequential momentum from April. In addition, nominal retail sales improved in May to 12.5 percent y-o-y growth, from 11.9 percent in April, highlighting the resilient consumer environment in the face of the slowdown. We will examine the most recent spate of economic data more closely in our upcoming Data Flash but the main headlines are as follows. Y-o-y growth in industrial activity, consumption and exports all improved to various degrees – even if they remain well below the trend growth rates of the past decade. Meanwhile, import growth was surprisingly negative (highlighting the lack of domestic demand), while overall outstanding credit growth remains at the lowest level since 2005, and growth in electricity production and headline fixed asset investment both eased from April. The property sector deteriorated further in May as well, with the contraction in property sales deepening to -7.8 percent through in the first five months of the year (from -6.9 percent in the year-to-April). So the narrative of a stabilizing economy over the past two months is only partially evident – and it is confined to certain areas: consumption and some industrial activity related to infrastructure spending.
Whither the economic reform program?
The stepped-up easing measures come on top of previous loosening through the first five months of this year, which included tax breaks for small enterprises, increases in funds for railway investment and shanty town renovation, encouragement by the PBoC for big banks to increase mortgage lending at lower interest rates, increased liquidity injections to lower the cost of funding for the banking system, and acceleration of local government fiscal spending.
The enhancement of such measures stands in stark contrast to the lack of movement on the economic reform agenda. No big-ticket items seem to have been put forth so far. The central government has highlighted the importance of designing a rationalized fiscal relationship between the center and the provinces without providing any detail of what such a program would entail. Furthermore, the leadership has widened the pilot program that will allow some local governments to independently issue bonds for financing purposes without increasing the overall quota for such placement – which stands at 400 billion RMB for all the provinces involved, a drop in the bucket for local governments that have an outstanding debt load of almost 18 trillion RMB at last count.
As such, a picture has emerged of a central government much more concerned with maintaining economic growth than focusing on rebalancing and reforming an economy that remains overly addicted to credit expansion and capital-intensive investment – despite growing inefficiency in the capital allocation mechanism. Furthermore, the fact that the center has become increasingly frustrated with local authorities who seem reluctant to implement even the tamest of adjustments to the bureaucracy highlights how challenging it will be to implement the more difficult economic reforms that could truly change the growth trajectory, such as forcing consolidation in sectors like steel and coal and liberalizing heavily constrained services.
The good news is that consumer attitudes and thus consumption spending seem to be proving quite resilient to the overall sluggish economic environment. Also, the beleaguered economy may finally see a short respite from the growth slowdown as the ever-growing list of incremental easing measures finally filter through for a bump to GDP growth in Q4 of this year. The bad news is that the next three months are set to see a continuation of the difficult growth dynamics and overall business environment that has characterized the past three quarters. And even despite a relative level of restraint in pushing through economic stimulus, long-term structural adjustments to the economic growth model are clearly taking a back seat to the desire to maintain an arbitrary level of GDP growth for the time being. Even more worrying is the likelihood that the surreptitious stimulus program will ultimately prove ineffectual. Growth is likely to tick up at some point late in this year, but only temporarily. The growth environment will continue to weaken in 2015, even as little has been done to address the economy’s structural challenges of deteriorating productivity and capital efficiency.