Gavyn Davies
Apr 26 16:22
At the IMF/World Bank spring meetings in Washington a week ago, downside risks to the Chinese economy were discussed solemnly, but calmly. There was no mood of crisis, no feeling that a major dislocation in the economy or the financial sector was imminent. Meanwhile, the surge in Chinese equity prices so far this year hardly seems to indicate an impending recession.
Yet there are signs of trouble ahead.
Real interest rates and the real exchange rate have both been rising at a time when the domestic credit market is under stress. Deflation has taken hold in the real estate sector and in the over-supplied heavy manufacturing sector, where much of the troubled debt is to be found. And the most recent quarter has seen GDP growth dipping to its lowest level since the global financial shock. It is becoming apparent that a much larger easing in policy might be needed to head off a hard landing.
Fortunately, this is now clearly underway.
The underlying growth rate in the economy has now been slowing for many years as economic rebalancing takes effect. In the Fulcrum model for economic activity, the long run growth rate is estimated to have slowed gradually from 11.5 per cent in 2007 to 6.5 per cent now. This decline has been both inevitable and, to a large extent, desirable.
Until recently, the model indicated that the actual growth rate in activity was tracking the underlying slowdown fairly closely. Although there has been much discussion about hard landing risks whenever quarterly GDP growth has dipped in recent years, this was never confirmed by our activity model.
However, the very weak industrial production data for March 2015, alongside declines in survey data, retail sales and investment, has resulted in a drop in estimated activity growth to only 5.2 per cent.
As the graph below on the right shows, the model’s probability distribution for GDP growth in the 2015 calendar year has shifted markedly downwards, with a much increased statistical risk of a sub 6 per cent outcome – one definition of a hard landing in the Chinese context.
Of course it would be wrong to place too much emphasis on one month’s data. But there are some underlying reasons for more concern than has been justified in the temporary weak patches for activity in the past couple of years.
Domestic demand has clearly been slowing as monetary conditions have tightened. Real interest rates have remained high, or have actually gone up, as deflation has taken hold in house prices and producer prices. Monetary growth has weakened, though up to now this has been largely because of an intended squeeze on the shadow banking sector.
There are two main routes through which the slowdown could develop into something much worse. The first is that the uneasy stability in the savings/investment relationship could change. Martin Wolf warns that investment could slow sharply in a decelerating economy.
Alternatively, there could be a rise in household savings in response to concerns about falling housing wealth, which is what happened during the US housing crash. Given the bubble-like surge in equity prices, this may seem improbable, but it would become more likely if the equity surge ends in a crash.
The second route, also reminiscent of events in the US in the last decade, would be a financial crash led by stressed loans to the real estate or manufacturing sectors. Last week, there were defaults by a property developer and a power equipment manufacturer, though many observers saw this as a deliberate and controlled decision by the authorities to inject some discipline into the credit markets. It is widely believed by investors that these stresses can be brought under control, though that is also what was believed about the Federal Reserve in 2008.
Until now, the monetary authorities have been disinclined to react aggressively to signs of economic weakening and financial stress, seeing them as part of the solution rather than part of the problem.
There has been no precipitous reduction in interest rates, no panic cuts in reserve requirement ratios (RRRs) and, crucially, no apparent desire to weaken the exchange rate. In other words, China has been the only major country to stand aside from the global pattern of unconventional monetary easing.
There are now some indications that this may be changing, with the authorities planning measures to ease monetary policy in three different ways:
Yet there are signs of trouble ahead.
Real interest rates and the real exchange rate have both been rising at a time when the domestic credit market is under stress. Deflation has taken hold in the real estate sector and in the over-supplied heavy manufacturing sector, where much of the troubled debt is to be found. And the most recent quarter has seen GDP growth dipping to its lowest level since the global financial shock. It is becoming apparent that a much larger easing in policy might be needed to head off a hard landing.
Fortunately, this is now clearly underway.
The underlying growth rate in the economy has now been slowing for many years as economic rebalancing takes effect. In the Fulcrum model for economic activity, the long run growth rate is estimated to have slowed gradually from 11.5 per cent in 2007 to 6.5 per cent now. This decline has been both inevitable and, to a large extent, desirable.
Until recently, the model indicated that the actual growth rate in activity was tracking the underlying slowdown fairly closely. Although there has been much discussion about hard landing risks whenever quarterly GDP growth has dipped in recent years, this was never confirmed by our activity model.
However, the very weak industrial production data for March 2015, alongside declines in survey data, retail sales and investment, has resulted in a drop in estimated activity growth to only 5.2 per cent.
As the graph below on the right shows, the model’s probability distribution for GDP growth in the 2015 calendar year has shifted markedly downwards, with a much increased statistical risk of a sub 6 per cent outcome – one definition of a hard landing in the Chinese context.
Of course it would be wrong to place too much emphasis on one month’s data. But there are some underlying reasons for more concern than has been justified in the temporary weak patches for activity in the past couple of years.
Domestic demand has clearly been slowing as monetary conditions have tightened. Real interest rates have remained high, or have actually gone up, as deflation has taken hold in house prices and producer prices. Monetary growth has weakened, though up to now this has been largely because of an intended squeeze on the shadow banking sector.
There are two main routes through which the slowdown could develop into something much worse. The first is that the uneasy stability in the savings/investment relationship could change. Martin Wolf warns that investment could slow sharply in a decelerating economy.
Alternatively, there could be a rise in household savings in response to concerns about falling housing wealth, which is what happened during the US housing crash. Given the bubble-like surge in equity prices, this may seem improbable, but it would become more likely if the equity surge ends in a crash.
The second route, also reminiscent of events in the US in the last decade, would be a financial crash led by stressed loans to the real estate or manufacturing sectors. Last week, there were defaults by a property developer and a power equipment manufacturer, though many observers saw this as a deliberate and controlled decision by the authorities to inject some discipline into the credit markets. It is widely believed by investors that these stresses can be brought under control, though that is also what was believed about the Federal Reserve in 2008.
Until now, the monetary authorities have been disinclined to react aggressively to signs of economic weakening and financial stress, seeing them as part of the solution rather than part of the problem.
There has been no precipitous reduction in interest rates, no panic cuts in reserve requirement ratios (RRRs) and, crucially, no apparent desire to weaken the exchange rate. In other words, China has been the only major country to stand aside from the global pattern of unconventional monetary easing.
There are now some indications that this may be changing, with the authorities planning measures to ease monetary policy in three different ways:
- The one percentage point cut in the RRR announced last week was larger than expected, and is clearly intended to hold down money market rates at a time when large scale capital outflows are tightening monetary conditions, and tending to reduce the PBOC balance sheet. It will “free” about RMB 1.3 trn of bank reserves for other uses. However, market rates still remain positive in real terms, and may need to be reduced further.
- It has been reported that the PBOC is contemplating a programme of unconventional monetary easing similar to the LTRO measures undertaken by the ECB in recent years, with elements of the UK’s Funding for Lending Scheme thrown in. This will be aimed at easing the overhang of local government debt, which is being rolled into longer durations via new “municipal” bond issues. Bonds acquired by the banking sector in this process will be allowed to be used as collateral for low interest short term liquidity provision by the central bank, as will other packages of approved new lending by banks. This should be seen as a form of targeted quantitative easing that indirectly finances public debt by expanding the central bank balance sheet. Although similar to a package announced in July 2014 to help small firms, this initiative could become much larger, since the problem of non performing local government debt is potentially massive.
- The authorities clearly intend to use the policy banks as an avenue for pseudo-fiscal expansion. Last week, it was reported that they will announce a capital injection of $63 bn into these entities from the foreign exchange reserves, presumably with the intention of enabling them to raise more finance to boost lending on infrastructure, agricultural projects and trade support. President Xi’s ambitious promise of a new silk road – one belt, one road – is becoming a reality.
0 comments:
Publicar un comentario