The dial is stuck on slow

China’s real GDP growth moderated from 6.4% y/y in Q1:19 to 6.2% y/y in Q2:19. Still several monthly data points surprised to the upside in June. Cumulative fixed-asset investment increased a fraction, retail sales growth recorded the highest growth rate since March 2018, and industrial production grew much faster than in May. These June numbers now push up our China Activity Index from 5.87% in May – the lowest in 15 months – to 5.96% in June.

Nevertheless, the outlook is humdrum. We still see Q1 as the high-water mark for 2019. The external headwinds are obvious: flagging global growth, and the US-China trade war. It hardly surprising that PMI indexes in Japan, Malaysia, South Korea, Taiwan and others have been in contraction for months. Both imports and export data has been poor and will likely deteriorate further. In China, policy support for private businesses and consumption has failed to move the dial.

Still, aggregate financing is up from 10.6% y/y in May to 10.9% y/y – the best outcome since June 2018 – but new bank loan growth fell to 13.2% y/y – the lowest this year. Worse still, medium- to long-term loans to corporates remain in negative year-on-year growth. The headline data is obscured by items such as discounted bankers’ acceptances which have surged by CNY2,683bn in the past year, at the expense of traditional loans. These loans are a useful source of cash, while waiting to get paid for sales already made; overpayment terms that have increased from an average of 56 days in 2015 to probably closer to 100 days currently. But these loans do little to boost economic growth. Manufacturing PMI implies a bleak outlook, and industrial profits remain in contraction. And now, producer prices are back to zero, heralding the unwelcome return of deflationary pressure. When it comes to consumption, the rebound in retail sales growth seems to have a lot to do with rising consumer prices but this is likely not sustainable. Ominously, survey data measuring items such as say expectations around future income, willingness of consumers to save, etc. imply that tax cuts have failed to offset the pressure on households: slower income growth, rising household debt, and a less certain employment landscape. The jump auto sales in June wasn’t thanks to suddenly renewed consumer demand; instead, dealers were giving deep discounts to clear inventory of cars not meeting now stricter emission standards.

Clearly, policy support – fiscal and monetary policy – is needed to stabilize growth. However, there are pitfalls. Firstly, easing real estate again would reignite concerns around asset bubbles and financial risks. To wit, the China Banking and Issuance Regulatory Commission has ordered Trust Companies to get the growth of their property financing businesses under control, identifying 10 that are prohibited to lend to the sector in Q3:19. Secondly, additional subsidies for consumption. Putting the pressure on local government fiscal positions aside, even if they were able to be effective after tax cuts have only had minimal success, the plan cannibalizes future demand. Thirdly, another surge in credit. Given the outlook for private firms, such funds could end up with SOEs. Yet, the NDRC stated this month quite clearly that it is against the rules to sustain ‘zombie enterprises’ by providing government subsidies and loans in violation of regulations. Fourthly, an outright rate cut would fly in the face of statements by the central bank, thereby undermining credibility. The PBOC has injected huge amounts of liquidity into the financial system in various forms over the past year, and already guided some short-term rates lower to reduce corporate financing pressure. Lastly, Beijing could weaken the currency. However, the People’s Bank of China has used its counter-cyclical adjustment tool liberally over the past two months guided the yuan stronger against the USD, fighting rapid depreciation, which may trigger capital outflows.

That leaves infrastructure spending. Beijing though has been nudging this needle since the start of the year. Unlike in previous years when infrastructure-related stimulus was overstated, Beijing has been active in this space but understatedly so. Local government bond issuance in H1:19 was CNY2.9trn (CNY1.3trn in H1:18), and special bonds for infrastructure increased by CNY1.1trn in H1:19 – half the annual quota, compared to just CNY400bn in H1:18. This pace will likely slow. The issue has been that much of the proceeds have gone to purchasing land. Last month the regulators made an adjustment permitting proceeds of special bond sales to be used for equity portions in major infrastructure projects, which could be helpful. However, for China to achieve a 7% y/y growth in infrastructure investment in 2019, an additional CNY750bn new investment needs to occur each month through year-end, up from an average of CNY450bn year to date. Just last year, infrastructure spending came in at CNY6.2tr, but in the first six months of this year the tally is just CNY2.7. Worse still, even if China manages 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. The Politburo is set to hold an important meeting on economic policy before end July; any policy change will be announced at that time.

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