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2019-05-09Macro `n Cheese

On a Slow Boat to China

The US-China trade negotiations have put the strength of the Chinese economy firmly back in focus. How bad is it? – That’s what Roger tries to find out this week.

Before you start reading, here's this week’s reading soundtrack: https://www.youtube.com/watch?v=AaPoFMPlSQM

In a couple of weeks, I’ll be heading to our Asian office to meet up with colleagues and clients, so I thought it would be a good time to catch up on regional developments, looking more closely at the Chinese economy which I think will be immensely interesting to follow near-term – especially, perhaps, from a European perspective.

Let’s start with the fundamentals. China is a success story like no other[1]. After a few hundred years – or so – in steady descent, trade liberalization and a very Chinese take on ‘market economy’ have propelled China back into its proper position on the world stage.

[1] Arguably, with the exception of Japan.

 

That said, the first phase of export catch-up is well behind China and the need to create a dynamic domestic economy to continue the convergence towards high income countries has been apparent for the last 10-20 years. Consequently, investments have increased, but the (change in) composition is not necessarily conducive to high value-added growth.

 

This has left China with some economic policy heavy-lifting to do. After a decade with an unparalleled rise in indebtedness, policy makers have been trying to ween the economy off its dependence on credit, but without much success, to be honest. Indeed, IMF and others have been fretting about the high and rising credit intensity of GDP for a long time, demonstrating that, on average, it has taken three CNY of credits to produce one CNY of GDP after the global financial crisis, whereas it only took around one unit before the crisis (implying an ever-rising debt ratio).

 

Of course, these developments have not passed unnoticed by market pundits. The sheer number of stories and anecdotal evidence purporting an imminent economic crash have by now approached those of Japan, another “perpetually doomed” economy.

Responding to recent economic weakness, the government has nonetheless changed its current tack from reining-in credit growth to trying to support growth with a host of measures, notably relying more on fiscal measures.

That said, the first thing that happened this week was a lowering of the Reserve Requirement Ratio RRR) for small and medium sized Chinese banks to 8% (from 10-11½% currently). That something in this direction was coming has been obvious after comments from, e.g., PM LI Keqiang and PBoC-governor Yi Gang in conjunction to the National People’s Congress in March. And, for sure, Trump’s trade-aggression over the weekend might have had something to do with the timing.

 

As has been the case over the last decade or so, whenever China is slowing, an easier monetary policy works its magic and – unsurprisingly – we already see a pick-up in survey data.

 

Turning to hard data the three components market participants tend to watch are: (1) investments, (2) consumption, and (3) exports. One thing to note is that the highly popular monthly time series for fixed assets investments (FAI) was not very reliable (due to double-counting, strange treatments of land, etc.), but the improvements made seem to at least imply that the FAI and the equivalent national account numbers (Gross Fixed Capital Formation) are more comparable.

 

That said, and as far as FAI goes, it would not be entirely surprising to see a small improvement in the second quarter due to monetary stimuli and an ongoing stabilization of financial markets (albeit limited by already high corporate indebtedness and the government’s continued desire to control debt growth).

Now, if we steer our focus towards consumption, the quality of the retail sales data has also been very much in doubt as it obviously has not captured a shift in consumption towards education, health care, and travels. In addition, the universal problem of capturing the high and rapidly increasing share of online retailers is almost certain to be a problem also for China (as can be seen from, e.g., the sales growth of Alibaba).

 

Despite, i.a., the cut in Value-Added Taxes (VAT) from 16% to 13%, starting April 1st, I notice that most observers are quite optimistic on the consumption outlook. Just a couple of weeks ago, the IMF hiked its 2019 forecast for China in response to strong policy stimulus. This is also good news for profit growth, which has been abysmal over the past couple of years, in particular for private enterprises.

 

How about trade, then? – Is it all horrible news due to the see-saw changes in the US-China trade negotiations? As I add the finishing touches to this text, financial markets are roiling after the release of weak trade balance data from China and increased tensions in US-China negotiations.

Admittedly, the trade balance does not look all too perky, but it’s a far cry from being disastrous – at least for now.

 

And to be frank (even though that’s not my name), I think it’s more important that imports are stabilizing, or even improving. After all, albeit from a primarily external perspective, the allure of China comes from the gigantic consumer market.

– An enthusiastic Zhang San stocking up on international goods is just what the world economy ordered. I look forward to meeting up with a few of them shortly!

 

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