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The most recent update of Fathom’s China Momentum Indicator (CMI) points to a further setback for China’s economy, with the March release suggesting that growth could be as low as 2.5% over the next year or so. This implies a much faster pace of deceleration than that reported by the official data. Notably, until early last year, our measure of China’s economic growth rate tracked that reported by the official data. The two now diverge wildly.
Two out of three constituent parts of our CMI have recently plunged to new depths. Electricity production fell in the twelve months to both February and March. Similarly, rail freight volume growth slumped to a six year low in February – ticking up only marginally in March. As a consequence, the volume remains almost 10% lower than a year ago.
Arguably, the authorities know that the economy is falling short of its 7% growth target and in a bid to moderate China’s hard-landing have enacted a further policy loosening. On the 10th May, the People’s Bank of China announced the third rate cut in six months, while acknowledging the ‘relatively big downward pressure’ faced by China’s economy.
The National Bureau of Statistics has since backtracked, releasing a rare statement ahead of this week’s data releases in which it insisted that the indicators remained within a reasonable range. To the contrary, retail sales growth slowed to the lowest twelve-month rate since February 2006. Industrial production expanded, but at a still lackluster 5.9% in the twelve months to April. This is less than half of the 13.4% pace achieved in the decade leading up to the global financial crisis.
In line with our expectations set out in our latest Global Economic and Markets Outlook (GEMO) for 2015 Q2, the PBoC is acting with caution, loosening interest rates slowly. The benchmark one-year lending and deposit rates were cut on Monday by 0.25 percentage points to 5.10% and 2.25%, respectively.
By the end of this year we expect the benchmark lending rate to have been slashed to 3% as China’s policymakers grapple with the slowing economy. Worryingly, evidence to date suggests that the PBoC is losing policy traction – with rate cuts failing to properly feed-through to market rates. This will inevitably complicate the transition away from shadow-based financing to bank lending. As a consequence, the stock of nominal bank loans – the third indicator used to calculate the CMI – rose by just 1.4% between February and March.
Total social financing, a measure developed by the Chinese authorities to capture the total stock of credit extended to non-state entities, has fallen to a six month low. Evidently, the monetary loosening that has been undertaken by the PBoC has been insufficient to stimulate enough lending through official channels to offset the state-induced contraction in shadow-financing.
In the latest Monetary Policy report the PBoC promised to create a ‘neutral and appropriate’ monetary environment, while preventing ‘excessive easing.’ They are correct to avoid this. Our own measure of non-performing loans is north of 20% of GDP for 2015. The official measure calculated by the China Banking Regulatory Commission is less than 2% – implausibly low in our view. Interestingly, even they could not deny the recent economic deterioration with the value of non-performing loans registering its biggest quarterly jump on record in the first quarter of this year.
This cautious monetary easing will in our view be insufficient to combat China’s mounting economic woes. Indeed, we believe China entered a hard-landing at the beginning of this year, confirmed by the growing wedge between our CMI and the official statistics. Eventually, China’s policymakers will be pressed into relinquishing the crawling US dollar peg and allowing the renminbi to gradually depreciate. A Fed tightening later this year may well be the trigger.
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