Still no sign of either stabilization or shift in policy

The already precarious position of the global economy has just received an unwelcome reminder from China’s National Bureau of Statistics underwhelming July data. The June numbers had managed to push up our China Activity Index from 5.88% in May – 15-month low – to 6.09% in June – but it’s now retreated to 5.90% again. The index has broadly been in decline for five months, from 6.94% in March.

The July data seems to confirm that Q1:19 was the high-water mark this year. We therefore foresee further momentum loss through Q3:19. There is little sign that the economy will stabilize. Could the cyclical low point then be next year instead of Q4:19?

Retail sales growth slipped from 9.8% y/y in June to just 7.6% y/y in July – except for April this year, this was the slowest pace since 2003. Last year, nominal retail sales growth expanded by just 8.1%, the slowest rate since 2002 – and, in real terms, it expanded at half the speed of the rate just 18 months prior.

This year has admittedly been worse because households have accumulated significant debt in recent years. In absolute terms, household debt surged by twice the speed of the rest of the economy, and since 2015, household debt to GDP has increased by 13 pps – largely on the back of a sharp increase in mortgage debt. The government has, correctly, focused on supporting consumption growth via tax cuts but, given the deteriorating sentiment of households about future income and employment, this has proven difficult.

Investment growth also slowed by over one pp in July, and private investment growth slowed from 5.7% YTD y/y in June to 5.4% YTD in July. The pro-business agenda, which has been championed by Premier Li Keqiang for years, exemplified in cuts to taxes and fees along with the deeper and better coordinated efforts to ameliorate pressures on SMEs, are proving unable to incur momentum for the real economy.

We reiterate that it is impossible to replace the non-productive investment with productive investment, thereby maintaining past rates of growth in fixed asset investment, which accounts for half of the economy – especially with stricter scrutiny on the allocation of loans by financial institutions. Worse still, even if China could manage to achieve an acceleration in infrastructure growth from 5%, this portion of the investment pie is dwarfed by manufacturing and real estate, limiting the broader impact on the economic trajectory.

Previous data has already showed that imports have contracted in seven out of the past eight months. In addition, when adjusted for seasonal distortions, industrial production growth recorded its lowest reading in 17 years. Further underscoring that the domestic economy is still softening, producer prices started contracting once again, triggering concerns that the 2012 to 2015 deflationary spiral is back, a period that culminated with major economic, financial volatility and the policy framework of supply-side structural reform. Already steel output has been cut in a host of provinces, and we expect more output curbs to spread to other upstream industries soon as well.

Moreover, total financing grew at a slower pace too in July. Of concern is the fact that RMB-denominated bank loans decelerated to the slowest rate since June 2018 – even though authorities are leaning on banks to boost lending to the private sector. In fact, medium- to long-term loans, which is a better indicator of genuine borrowing by corporates, declined from 0% YTD y/y in May and June to -2% YTD y/y in July.

Meanwhile, a slippery exchange rate and the turbulence in Hong Kong could negatively affect the Mainland. The currency has weakened relatively, slipping by 3% in the last four weeks. For now, the PBoC is still focused on the rate of change more than the direction and are simply looking to manage further depreciation against the USD (as opposed to reversing it), suggesting that Beijing is not overly concerned that a bout of currency weakness will cause significant capital seepage. And, in fact, against the CFETS basket the currency has been broadly stable.

Capital outflows are occurring, but not yet a worrisome level. In H1:19, China has experienced a net outflow of USD120bn, which is the most in four years, above 2012 levels (when the anti-corruption campaign commenced), albeit still just half the volume of 2015 and 2016.

Worse still, a mini-crisis is brewing in the small to medium-size banking sector. Over the past two months the regulators have had to focus attention on measures – bailouts, takeovers, and consolidation – for three small banks: Henfeng bank, Bank of Jinzhou and Baoshang bank. Authorities will take this as a clear reminder of the risks of unwinding the hard-fought gains over the past two years in reining in risk, and this is the core reason why they continue to remain reticent to stimulate. Beijing recognizes that such measures do more long-term harm than short-term good. Consider that last week the Ministry of Finance was talking down the prospects for fiscal stimulus in H2:19, suggesting that many local governments will have their budgets adjusted lower as the government’s fiscal position is deteriorating. This new policy approach is positive for China’s medium-term economic outlook – but it also does imply further near-term momentum loss.

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