Pacific Money

China’s Tough Policy Choices

Data continue to show a slowdown. Will the government cave to pressure for further stimulus?

China’s monthly data releases continue to show a trend of slowing growth and economic activity. Given that we are now in the last month of the second quarter, it is likely that second quarter GDP growth figure is going to continue the disappointment. Already expectations are building for the government to ride to the rescue once again, but a slowdown in headline growth and especially investment is almost certainly necessary if economic rebalancing is to get seriously underway.

As China moves into its famous Dragon Boat Festival holiday, a slew of data has already been released covering the month of May. The picture being painted is not particularly encouraging for those expecting an imminent recovery in China’s headline GDP rates. Most disturbing of all perhaps was China’s trade data for May. Year-on-year  growth in exports fell well short of expectations at only 1%, whilst imports (which would theoretically rise faster as China rebalances towards its much heralded consumption-driven economic model) actually fell by 0.3%.

The trade slowdown is not as bad as it seems though, or to put it more accurately, the previous months’ strong performance was not as strong as it seemed. A crackdown on the recent anomalies in Chinese trade data, now believed to have included large amounts of false invoices due to the misuse of “bonded areas” and special trade finance channels by entrepreneurs engaging in hidden capital movements and “carry trade”, has probably returned the data to a much more reliable picture – China’s trade performance has been poor for months. We are yet to see any downward adjustments to China’s first quarter GDP figure of 7.7% to reflect the lower real exports.

Small companies, whose performance is reflected in the China Official Purchasing Managers’ Index (PMI) for Smaller Companies and also somewhat in the HSBC-Markit China PMI, are struggling. Both gauges showed contraction for May, even as the official PMI (focusing more on larger and state-owned companies) showed weak expansion for the month.

Other data, including Fixed Asset Investment (FAI) and Industrial Production, were weaker than expected. This news is positive for those wanting to see a rebalancing, even if it may suggest there will be further pressure on growth in the near future. May consumer inflation eased, and producer price deflation worsened. Retail sales, in a rare bright point, expanded 12.9% year on year.

This data sets China up for a particularly interesting next couple of months. Growth rates have fallen dramatically from the giddy highs of double-digit growth just a few years ago. Whilst this is undoubtedly a very healthy development for China’s future growth sustainability, the slower growth is bound to create pain for the economy. Ideally, investment levels and overall growth must slow enough that consumption growth can outstrip them for several years, thus rebalancing the economy away from the current wasteful and debt creating model.

Despite having made statements stressing that the government is willing to endure lower growth rates, there is building expectation (read: “hope”) after this latest batch of data that Li Keqiang and his administration are planning to provide some sort of stimulus again. Since the government has proven much more effective in the past at stimulating investment-driven growth than consumption, there are some hard choices to be made. The pressure will mount, particularly if second quarter GDP reflects the poor monthly numbers we have been seeing so far. The coming few months will thus show us how confident the new government feels and whether they feel secure enough to allow the GDP rate to approach or fall below the 7.5% target.