We believe China’s substantial monetary and fiscal stimulus is finally translating into stronger economic activity. Whether this boost can be sustained or fizzles out under the weight of the large structural imbalances in the Chinese economy may be one of the defining features of this year’s global economic and investment landscape.
China’s economic stimulus started in late 2014 and continues into the present. The substantial stimulus package has been a response to the slowdown in Chinese economic growth.
On the monetary policy front, the People’s Bank of China (PBoC) has cut benchmark lending rates from 6% to 4.35% over the period and has lowered required reserve ratios – the share of consumer deposits that commercial banks are required to hold with the central bank – from 20% to 17%.
Meanwhile, fiscal policy has also been loosened. Increased government spending has led to a rise in the budget deficit as a share of gross domestic product (GDP) from 1.4% in 2014 to 3.1% in 2015, and this is likely to touch 5% over the next few years. Policymakers have also enacted a range of ad hoc stimulus measures, such as relaxing property purchase regulations, adding liquidity to the equity market and engineering a depreciation of the renminbi against a basket of other currencies.
A certain amount of moderation in the pace of growth is to be expected as the country rebalances away from industrial and export-led activity towards services and consumption-led growth, but in our view, the slowdown has been far beyond that implied by rebalancing.
While not obvious from the headline gross domestic product (GDP) figures, which show growth moderating only very slightly, from 7.2% in 2014 to 6.9% in 2015, other measures show activity slowing sharply in China over the past year.
For example, industrial production declined by 2.0%, and imports fell by 14.2% in 2015. Our own measure of Chinese economic activity, which tracks a range of indicators, suggests that “true” economic growth may have dipped as low as 5.0% last year.
But in the first few months of 2016, there appears to have been something of a turnaround. The Purchasing Managers’ Indices (PMI), which are survey-based measures of activity, have picked up, inflation has strengthened and our own activity proxy has sharply rebounded. Indeed, after a long period tracking below the official GDP numbers, our measure now suggests that true economic growth may actually be above the official measure.
So is this upturn built to last?
There are good reasons to expect a resumption of last year’s slowdown in economic activity. After all, deep structural imbalances in the Chinese economy remain a rapid build-up of private sector credit relative to GDP, leading to high share of non-performing loans in the banking system, overcapacity in the manufacturing sector (which leads to deflationary pressures) and strong house price appreciation (which leads to an excess supply of property).
There are good reasons to expect a resumption of last year’s slowdown in economic activity.
If anything, the stimulus efforts of the past 18 months may have exacerbated these imbalances by boosting credit growth, encouraging investment in overcapacity sectors and further stoking house price inflation. These imbalances may offset the boost from stimulus by acting as a drag on economic growth. In a worst-case scenario, they could trigger a “hard landing” that results in a rapid slowdown in Chinese growth.
But the upturn in Chinese activity could prove more durable. Policymakers began adding stimulus to the economy 18 months ago. It is only now that the effects are starting to show in the data. There is therefore another 18 months’ worth of stimulus “baked into the cake” that may continue to boost the Chinese economy.
Historically, cycles of Chinese economic activity around longer-term trends appear to last for just over a year on average – again lending support to the view that the upturn could continue for a while yet. Finally, the 19th National Congress of the Communist Party of China will be held in the autumn of 2017, when up to five new members of the seven-person Politburo Standing Committee could be appointed.
President Xi Jinping may seek a set of appointments that aids his own consolidation of power, a goal that would presumably be easier in an economic upturn. This argues for the continued use of policy stimulus to ensure a favorable economic backdrop until then.
Chinese growth concerns were a key trigger for the sharp fall in markets in August and September last year, and were one factor that dissuaded the U.S. Federal Reserve (Fed) from hiking interest rates in September 2015. Those concerns returned again at the start of this year, when financial markets sold off sharply for a second time in the space of a few months.
Surveys of investors regularly show a China hard landing as high on the list of worries. But with the first signs of China’s substantial policy stimulus now showing in the economic data, the country may yet surprise markets to the upside this year.
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