CONCLUSION: We maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
The Data: Setting aside the JUN Industrial Production, Retail Sales and Fixed Asset Investment YoY growth rates – which, on balance, slowed very marginally from MAY – Chinese Real GDP growth slowed in 2Q12 to the weakest pace since 1Q09 – a disturbing thought, given that in 1Q09 the global economy was mired in the deepest global recession since the 1930s.
The Reaction: The benchmark Shanghai Composite Index closed flat on the day and remains in a Bearish Formation. The Chinese yuan traded down only marginally on the day (-0.1%) and the non-deliverable forwards markets continue to price in 60-140bps of incremental weakness vs. the USD over the NTM. A critical divergence to note is the more bearish expectations in the offshore market (i.e. USD/CNH cross), which is likely a sign of international investors holding a more bearish long-term view of the Chinese economy than mainlanders (more easing and/or more capital outflows expected). Moreover, this has been the case since the start of the year. Please refer to our APR 16 note titled: “FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKET” for our bearish TAIL-duration thesis on the Chinese currency.
The Context: It’s worth remembering that this was a policy-induced slowdown. As we initially suggested way back in our 1Q10 Macro Theme “Chinese Ox in a Box”, the Chinese government has engineered a fairly dramatic slowdown in domestic economic growth (the rate of Real GDP growth has fallen -36% since its 1Q10 cycle peak) – largely on the strength of subsequent introductions of property curbs and post QE2 rate-hikes. Net-net, we don’t see any reason for Chinese policymakers to overreact and respond with any major fiscal stimulus or loosening of the aforementioned macroprudential measures currently weighing on demand in its property market. Our view is supported by recent commentary from key Chinese policymakers and central planning agencies:
- Premier Wen Jiabao (JUL 7):
- “Restricting speculative demand and investment in property must be made a long-term policy.”
- “We must unswervingly continue to implement all manner of controls in the property market to allow prices to return to reasonable levels. We cannot allow prices to rebound, or all our efforts will come to naught.”
- “Market expectations about property prices are changing and citizens are worried prices will rise again. Signals in the market are chaotic and misleading and speculative information must be stopped.”
- “Local governments that introduced or covered up a loosening of curbs on residential real-estate must be stopped.”
- “Property controls are still in a critical period and the task remains arduous.”
- “The government must promote the study and implementation of changes to the property-tax mechanism, and to speed up the establishment of a comprehensive long-term mechanism and policy framework for controlling the property market.”
- Ministry of Housing and Urban-Rural Development (JUN 19):
- Identified media reports about changing policies as “distorted” and pledged to “steadfastly continue existing policies”.
- China Banking Regulatory Commission (JUN 14):
- Issued a three-sentence statement on its website labeling media reports about relaxed restrictions on home lending as “complete misunderstandings”, “sheer fabrications” and/or “deliberate misinterpretations possibly intended to manipulate the market”.
- Peoples Bank of China (JUN 14 – roughly one week after the first rate cut):
- Issued a brief statement calling allegations in the media that the central bank had loosened restrictions on the property sector “deliberate misinterpretations” that “sensationalized” the bank's policy.
- The National Development and Reform Commission (JUN 12):
- Publicly deemed an article about a real estate development “sheer fabrication”.
All told, we feel comfortable maintaining our guidance to not expect much from the Chinese economy over the intermediate term – especially given that Fixed Capital Formation accounts for roughly half of Chinese GDP at 46.2%, having taken a fair amount of share from both Private Consumption and Net Exports over the last five years. As an aside, when the central plan calls for growth at all costs (as it did in the years leading up to 2010) an overreliance on incremental CapEx tends to be the most natural route, usually resulting in a speculative boom in property prices as the supply of credit expands faster than the discretion of those institutions responsible for extending it (a la China circa 2009-10). More on this later…
While our predictive tracking algorithms do suggest that the slope of Chinese Real GDP growth may base and potentially inflect here in 3Q, we are not of the view that any infection would be meaningful or the start of a sustained uptrend in Chinese economic growth. Refer to our OCT 18 thought piece titled: “PUTTING CHINA INTO PERSPECTIVE” for more details behind our thoughts that the Chinese economy has more than likely undergone a structural downshift in rates of economic growth.
The aforementioned conclusions on China’s property market and overall economy carry negative implications for industries and sectors that cater to the supply and demand dynamics of China’s domestic real estate market. The following micro data point lends credence to this view:
Sany Heavy Industry Co., China’s biggest maker of excavators, lowered its sales forecast for the equipment as slowing economic growth and government curbs on property market sap demand. Excavator sales may increase 10 percent this year, slower than a previous target of 40 percent, Vice Chairman Xiang Wenbo said in a July 11 interview in Changsha, Hunan province, where the company is based. Sany will still outperform the industry, which may see a fall in demand, he said. (Bloomberg; JUL 13)
Prices in China’s domestic rebar market also lend credence to this view:
Net-net, we maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth.
Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
Keep these thoughts front and center as you ponder the TREND and TAIL slopes of Chinese economic growth. Have a great weekend,