China’s August macro data: bad, but not surprisingly bad11 September, 2012, 18:48. Posted by Zarathustra
Incoming August data were bad, but lowered market expectations have certainly removed any possibility of nasty surprises. With just two and a half weeks left before the quarter ends, we can claim with high certainty that Q3 GDP growth would be slower than Q2. (Read August macro data review: Inflation, Industrial production, Retail Sales, Fixed asset investment, Trade, Monetary statistics).
The consensus has become rather more pessimistic than they were about China as incoming data continued to deteriorate, and monetary easing and government spending has not come as quick and as aggressively as many have hoped for, and that the crowd has overestimated the effectiveness of stimulus.
The street has been revising down growth forecasts after virtually none of the “signs of recovery” that only they saw have turned out to be real. UBS last week revised 2012 full-year forecast to 7.5% yoy, and down to 7.8% yoy in 2013. Earlier, Barclays has also revised 2012 full-year forecast to 7.5% yoy and 7.6% yoy immediately after most of the key August macro data were published, a second downgrade in a month or so. Even some of the consistently bullish research house is sounding oddly bearish (relative to their own). For instance, Morgan Stanley revised their 2012 full-year forecast from 8.5% yoy to 8.0% yoy. Although it remains very bullish, they are now seeing more downside risks to their forecast.
The worse-than-expected slowdown is a combination of too high an expectation on the strength of the economy, as well as the ability and willing of the government to actually hit all of its targets. On top of that, of course, is the fact that Chinese economy is simply not as strong as it looks.
There has been a massive misunderstanding about what monetary policy tool can actually do to help. We have expected for many months that reduction in reserve requirement ratio and interest rates will not help monetary condition, and now Bank of America Merrill Lynch discovers that the rate cuts, RRR cuts, as well as open market operations have not actually eased monetary condition, both in terms of easing liquidity as well as actually lowering borrowing costs (see our guide to China’s monetary policy).
There has also been an expectation, which has been too high, about government fiscal stimulus. Similarly, we have been saying that the government will be slow about embarking on aggressive spending, partly because the last stimulus is not viewed favourably within the country. And as expected, there have been a lot of talks about stimulus, but most are just talks.
However, for the first time for more than a year, we suddenly find ourselves not significantly more bearish on China than the crowd, which is interesting.
Certainly, we see the current slowdown as a structural change, that the level of growth rate in the previous decade is unlikely to be seen again. For now, either the country continues to invest in fixed assets or infrastructure to sustain growth, or it stops. If it stops, or slows, it will bring down economic growth with it, and there should be no question about that. We have to stress that by saying that there is an over-investment, what really matters is the investment relative to China’s current economic output, whether that economic output (or income) level is sufficiently high to generate enough return on existing and new investments. Overwhelming evidence suggests that the answer to this question is no, so even though China might well need even more fixed asset investments in the next 100 years, the pace of investment must slow now.
The consequence of slowing investment for China is easy enough to understand. While the economy will be rebalanced towards consumption, the rebalancing will come in the form of much lower overall growth. However, the volume of debt is complicating that matter, and it is clear that if the government does not step in aggressively by ramping up investments again, the short-term prospect could be very bleak.
But we think the worst case scenario of large-scale defaults with full-blown banking crisis and banks failure is not very likely as the government will do something reactively to support growth. In fact, some investments are indeed being ramped up (if you want to call them “stimulus”, by all means). Infrastructure investments have increased, as we noted in the case of railway, although not enough to offset the weakness in manufacturing. Loans has picked up strongly, and perhaps more curiously, we saw some dramatic increase of trust loans and entrusted loans in the aggregate financing accounts, and bond issuance has picked up (we will have more on aggregate financing accounts later).
These are completely going against the objective of cleaning up the shadow banking mess and rebalancing, and will only delay credit risks from materialising. Nevertheless, it will help to support growth in the near-term. The size of investments that will actually be realised will most likely be much smaller than what has been “planned” and “announced”, and thus the support for growth will probably be small, but we believe it will certainly be better than nothing.
We are not changing our long-term view for the time being, and we struggle to see any real bright spots in August macro data. Downside risks remain as enormous as it was, but for the first time in many months perhaps, we are not getting more pessimistic for the near-term future.