China Economy: Slowdown Underway13 May, 2011, 2:14. Posted by Zarathustra
Tags: Economy, People's Bank of China
Last month, some rumblings on the market suggested that the tightening cycle might have come to an end soon. Yet I have suggested that the Chinese government will make a mistake if tightening cycle ended then because the economy had not slowed much but inflationary pressure was still high. Since then, there have been some more tightening, both in terms of interest rates as well as reserve requirement ratio (the latest one came out just hours ago).
The above-consensus inflation data for April and other disappointing figures such as retail sales and others have prompted wide range of responses among economists and commentators. While one economist from the China’s planning agency suggested that China should cut interest rate towards the end of the year, many more people thought that China’s inflation has gone somewhat out of control.
So what is my take? In short, there are signs of slowdown, yet inflation remains high, so the People’s Bank of China may still continue to tighten policy for the next few months before they can claim any success over the inflation fight. However, the risk of so-called “hard-landing” has increased somewhat as the slowdown of economic growth means a smaller room for further tightening without stalling growth.
Below are some assessments on some recent data and reports.
Inflation is still high, more broad-based than previously thought
Source: National Bureau of Statistics
Inflationary pressure is still very high. Although food prices inflation was still the biggest driver last month, on an month-on-month basis, food prices have dropped thanks to a slump in vegetable prices. Yet other non-food items have managed to offset all the fall in food prices.
Manufacturing is slowing, inventories level is increasing somewhat
Source: China Federation of Logistics & Purchasing:
The purchasing managers index has been hovering at a somewhat low level for the past few months, albeit still in a growing territory. However, the finished goods inventory sub-index has been over 50 for 2 months. Historically, it appears that the inventories level only rise during sharp slowdown in activities (which makes sense, of course). Elevated inventories do not seem to be a particularly good sign, and unfortunately the input price sub-index continues to suggest high inflationary pressure. The industrial production data yesterday confirms the the slowing of industrial production growth, with somewhat slower PPI inflation.
Investment is still strong, yet may run out of steam
Fixed-asset investment, the true driver of China’s economic growth, is still growing strong. Year-to-date, fixed asset investment grew by 25.4% compared to the same period a year ago (nominal term). However, fixed-asset investments may fell later this year. Likewise, real estate investments are still growing strong, but tighter credit for real estate developers may slow real estate investments towards later part of this year. Of course, China is still aggressive in trying to build affordable housing in response to high home prices, thus I am less certain on how the picture on investment is going to play out in the remainder of this year.
Real estate market is cooling only slightly, but developers are squeezed
Recent reports and data from various sources suggested that real estate prices in the secondary market were mostly stable amid more tightening measures being introduced, while prices in the primary market varied widely as some real estate in poor locations were sold at lower prices. However, transaction volume has dropped sharply. Recent closure of Midland Realty (1200.HK) all Shanghai branches is a perfect manifestation of the cooling in the real estate market in terms of transaction volume.
As a result of slower sales, real estate developers have recorded decline in earnings, higher inventories and higher debt. The probability of some of the weaker players in the real estate market having some financial difficulties has increased, in my view.
Developers are squeezed, and buyers can’t get mortgages
The Chinese government has already tightened credit for home buyers for a few times, effectively making mortgages for third homes impossible. Yet some banks in Zhejiang are tightening the lending to first home buyers, increasing the down-payment requirement to 40%.
The government and banks action would effectively reduce demand for apartments, giving real estate developers another blow.
Retail sales growth is slow
Finally, retail sales growth has slowed in April, increased 17.1% compared to a year ago (nominal term) vs. 17.4% in March. It shows that the progress of rebalancing the economy has been remarkably slow, and in the event that fixed asset investment does slow in the remainder of this year, retail sales growth may not be able to compensate the slack.
The economy is slowing, but not enough.
However, when it is slow enough, it may be too slow
On the whole, there is a slight slowdown in economic growth towards the end of first quarter and early second quarter, yet the slowing of activities has not helped bringing inflation down to the acceptable level (or the target of 4%). As the government remains very determined in bringing down inflation and property prices while showing relatively little concern regarding growth so far, further tightening is still possible for the next few months.
Few months ago, I have already suggested that China needs a recession or a significant slowdown to end inflation. The data over the last few months support this view so far, as we have finally see some signs of slowdown while inflationary pressure remains high. I believe the ideal scenario of lower inflation while maintaining high growth is very difficult, if not impossible, and most people seem to have overestimated the Chinese government’s ability in engineering this so-called “soft-landing” scenario.
As the slowdown is underway, the room for further tightening has narrowed somewhat if growth has to be maintained. That means if tightening continues at the current pace, the probability of a so-called “hard-landing” in the second half of the year will increase substantially.