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Inside China 15 April 2019

From red to amber

Jeremy Stevens

Markets were bolstered by better than expected data out of China last week. The underlying credit cycle now seems to have bottomed out. Total Social Financing (TSF) increased by CNY 2.86tr in March – far higher than the expected CNY1.85tr. Overall credit growth accelerated from 10.1% y/y in February, to 10.7% y/y in March. Longstanding trends imply that the acceleration in credit expansion runs in tandem with economic growth – albeit with a six- to nine-month lag.

Some are calling the bottom in the cycle now, which still seems premature to us. From PMI (a diffusion index or sentiment-based indicator), to prices (buoyed by pork prices), to trade (still contracting imports suggest still weak internal demand), the data can be nitpicked. More data this week ought to reveal more. That said, our dashboard of more than a dozen macroeconomic metrics that we pay close attention to are showing signs of improvement. However, they are only just turning from red to amber.

And, looking ahead, a number of gusty headwinds remain. Consider that US President Trump stated early in April that “within the next four weeks or maybe less, maybe more…something very monumental could be announced.” Both the US and China have been making such diaphanous statements. Sentiment therefore has ebbed and flowed on any resolution to this trade war.

Until a trade deal has been delivered, the abiding risk is that talks end unresolved. Indeed, it has always been our contention that the thornier issues, such as intellectual property protection, technology transfers, non-tariff barriers, and cybersecurity issues, cannot be resolved in one static agreement. Thus, discussions will drag on. Probably the stickiest of sticky points is the enforcement of benchmarks — because meeting whatever metrics are agreed upon over the ensuing years could hold markets hostage, resulting in the wheels coming off again. 

Nevertheless, discussions have guided policy tilt from the Chinese side. For instance, government officials have been taking local governments to task for “disadvantaging foreign companies”. To boot, the National Audit Office (NAO) published results of a Q4:18 inspection of local governments, reporting that a few dozen local governments have “mistreated foreign businesses”. Herein lies one positive implication of the US-China trade war: to attract overseas investment, the government is keen to create a better environment for business – both foreign and private domestic businesses.

This pro-business agenda is evidenced in tax cuts. The largest of these came into effect in April – and deepening better coordinated efforts to ameliorate pressure on SMEs. Recall that this year’s Two Sessions made it clear that 2019 would focus on improving the business environment. Since then, the State Council outlined six focal points: improving the market environment and ensuring fairer competition; easing financing constraints for SMEs (via loan re-discounting and so on); reducing fees; supporting SME innovation; improving service support for small companies; strengthening policy coordination via ongoing inspections into the on-the-ground issues faced by SMEs. These measures are the heartbeat of the government’s approach to supporting the economy but are likely to be less immediate in manifesting in data than the previous credit-fueled approach.

One predictable, but less favourable, outcome is the host of central government entities reducing expenditure. That is logical, given the tax cuts squeezing government revenues streams. In fact, nearly half of the central government departments plan to reduce spending this year. The budgets reflect Beijing’s call for prudence and/or are forced to do so after Beijing committed to reducing tax by USD300 billion in 2019 to lighten the burden on businesses. Meanwhile, significant monetary easing is not currently on the cards, as monetary metrics are benchmarked to nominal GDP growth. Granted, targeted lending, bond issuance and RRR cuts are part of the plan. So much so, that domestic traders expected the PBoC to cut the RRR in the first week of April. Nevertheless, this is the first cycle in decades of monetary and fiscal policy not working in tandem, hampering the near-term growth prognosis. 

The crucial real estate sector is rather soft — but, steel prices should rise. Due to subdued PPI, authorities are now reining in production in major steel producing centers. Steel mills in Tangshan and Handan – the two biggest steelmaking cities in China – will be required to continue production restrictions in the second quarter, cutting back the operations at about 20% of their blast furnaces under the restrictions in Q3:19, from 30% over the past five months.

Interestingly, FX reserves have increased each month this year – if marginally – indicative of a remarkably stable currency market; the key driver has been changes in asset valuations. Nevertheless, the re-emergence in capital flowing out of China is still a concern. On this score, global bond investors have continued to purchase Chinese bonds in response to Chinese government and policy bank bonds being added to the Bloomberg Barclays Global Aggregate Index over a 20-month period. This could well see other international index providers include yuan-denominated debt into their global benchmarks. Such inflows are estimated at USD 150 billion in the near term — to potentially USD1trn over five years.


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