This January new loans granted in China totaled CNY 738bn. “Not bad” I hear you cry! However, in the context of expectations of CNY 1tr, and a 29% contraction year-on-year there’s clearly something of a liquidity squeeze going on.
The sharp drop in lending has taken M2 growth to 12.4% year-on-year…the lowest pace of growth since 2001. In fact, M1 shrunk this January by 6.87%. Yes yes yes – there’s the impact of pre-New Year spending, but the 12 month RoC shows growth at 3.1%, the lowest since this data started being collected in 1990. In nominal terms M1 has only increased CNY 813bn over the past 12 months. This is around the same amount as the mid 2000 when China’s economy was significantly smaller than it is today.
There might be rebounds in the coming months, but don’t be fooled – monetary conditions are clearly tighter than most people think. This shocking January data is the antitheses of exactly 3 years ago when Chinese monetary data shocked everyone with the strength of growth that the PBOC unleashed in the face of gridlocked capital markets and industrial activity.
This is clearly going to affect mostly those sectors most dependent on credit, such as real estate development. This is going to have wider knock on effects.
While most people are not heavily invested in China, one should readjust their holdings in anticipation of the fall out. Here’s one idea…
This slowdown is going to impact the fertilizer, agrochemical and petrochemicals sectors. While we all obsess over the monthly WASDE reports, and machinate over the upcoming Chinese potash negotiations, I contend that something bigger is at work. A slowdown in China is going to impact corn prices, and with it the prices of the aforementioned sectors will be heading south. I don’t believe recent shutdowns by the likes of Potash Corp are enough to salvage the bottom line in 2H12. I readjusted for this a while ago, but it’s not too late.
(Also note – Indian and Brazilian lead macro indicators are not rosy for chems/agchems either. In addition, note the pressure to Indian fertilizer subsidies, and pressure to Chinese fertilizer exports).
So we wake up this morning with the news that the official PMI data shows a contraction in Chinese manufacturing activity for the first time since February 2009. This follows the HSBC survey published a couple of weeks ago which similarly illustrated a contraction. In this context it’s easier to understand the reduction in RRR yesterday afternoon. That reduction added some $63bn of liquidity to the Chinese economy.
Clearly the Government sees that the economy is not in for an easy ride. I mean after steadily raising the RRR in 12 steps since January 2010 from 15.5% to 21% (a record), and then leaving them since June 2011, this is a watershed moment. While commentators yesterday lauded the move as the PBOC’s attempt to steer the economy to a soft landing I would prefer to describe the move as follows: A long running policy of loose monetary conditions led to an influx of speculative capital. The change in direction (i.e. to tightening in Jan 2010) combined with a huge acceleration in housing construction has killed the boom, created distress and the PBOC is now waking up.
Initial loosening is generally greeted with joy (note markets were buoyed somewhat way before the announcement of combined central bank activity yesterday to put a band aid on the Euro crisis). However, within time the market will see that the damage that precipitated the change in monetary policy is too big for a gentle loosening. As such I expect Chinese economic conditions to continue worsening (today’s PMI data is one example), and the PBOC to take more agressive moves to loosen credit conditions. This will heighten the impact on those assets that were tied to the prior boom. In this case I would expect damage to significant parts of the EM equities, fixed income, and commodity complex, in addition to pain in the domestic real estate market. Don’t say I didn’t warn you.
Also note – there’s a chance this could spill over to the banking system.
PS – some additional color on the PMI data. New orders 47.8. Export orders 45.6. Note that the export sector’s value added accounts for only 10% of GDP (yes – only 10%). As such, domestic weakness is most likely to be the driver of GDP deceleration in the coming months. Index of finished goods inventory rose to a record high. Tobacco, transport equipment and petrol were above 54. Below 43 were textiles, chemical fiber and plastics, and ferrous metal. The biggest losers were electrical machinery and special purpose equipment.
Growth spurred by lending
Last week economists were busy increasing their 2009e China GDP forecasts to around the magic 8% figure. The hike in new credit during 1H09 was surely a major contributing factor. During the first half of the year Chinese banks lent a record Y7.37bn, 300% larger than 1H08, and 47% higher than the government’s full-year 2009 Y5bn target.
Walking the tight-rope
The government is walking a tight rope, and will have to manage the economy to prevent assets bubbles, bad loans, and inflation, whilst simultaneously accounting for potential deflation (currently a concern in the US), and damaging shocks to the flow of capital.
President Hu Jintao told the Politburo on Thursday that the recovery was still nascent, and as such China would maintain its “relatively loose” monetary policy and proactive fiscal policy. On Saturday the People’s Bank of China (PBOC) said it “would guide loans to grow appropriately” and “will aim at better allocation of credit in the real economy.
Mopping up liquidity: Y100bn of notes announced
The PBOC has announced the issue of Y100bn of one-year bills to prevent a surge in lending in 3Q (note: July is historically China’s slowest month for new loans). According to Caijing magazine the PBOC has ordered the Bank of China (the county’s third largest lender) to purchase Y45bn of the notes, after the bank lent more than any of its competitors during 1H09. The notes carry 1.5% interest rate (lower than the general 2.25 deposit rate).
Expectation: measured approach – reserve rates to rise
I expect the government and its organs to continue taking a measured and pinpointed approach to ensure growth and suppress bubbles. As well as the new notes, I see banks reserve rates increasing from their current 15.5% for larger lenders, and 13.5% for smaller banks. I see an increase in reserve rates most likely to wait until 2010, unless data for credit extended in July and the coming months exhibits any significant spikes.