China will slow again by next year (members)

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Some good material from around the web today supports MB’s current base case for the Chinese economy – that it’s current stabilisation is not a renewed cycle of credit-driven activity and that reform will move forward again before long, culminating in a steady slowing over the next few years.

The first piece is from Nomura via FTAlphaville, which shows stabilisation has succeeded in lowering corporate bonds yields materially:

Liquidity injections and targeted easing so far this year has had a material impact on corporate bond yields. Corporate bond yields have dropped across the rating spectrum, while a similar narrowing of spreads can be seen relative to Chinese government bonds. Data provided by the China Government Securities Depository Trust & Clearing Co Ltd (chinabond.com.cn) shows that both 1yr and 5yr AA-rated bond yields have fallen, from highs of 7.22% and 7.63%, respectively, at the start of the year to 5.38% and 6.53% today.

The stabilization of GDP growth and monetary and liquidity easing measures taken by the People’s Bank of China (PBoC) – targeted bank reserve requirement ratio cuts, re- lending, Pledged Supplementary Lending (PSL) facilities – and relatively well-contained default risks in H1 have successfully brought down financing costs. This is reflected in the lower corporate bond yields and the relative spread narrowing between different rated bonds, across the credit spectrum. For example, the 1yr spread between AA and AAA rated corporate bonds hit an historical tight at 39bp last week, before widening back to 52bp…

All to the good. Authorities want to see cheaper debt for business. But, as I noted yesterday, we’ve also seen a recent tightening in interbank credit. ANZ offers a take on why:

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  • China has seen signs of slower capital inflows in the past months, and we view this is good news, as the country already has massive reserves, and two-way capital flows will increase the exchange rate flexibility and thus enhance the effectiveness of monetary policy in China.
  • China’s money supply is often influenced by the capital inflows. As capital inflows moderate, the supply of reserve money also slows, which then tightens the inter-bank market liquidity. We believe that the current tightening monetary condition will heighten the deflation risk and make it more difficult for the government to achieve the 7.5% growth target.
  • We think that the PBoC could conduct reverse repo operations to stabilise the short-term market rates. It will also be more active to adopt the newly launched Pledged Supplementary Lending to improve liquidity and guide lending in longer tenor. In addition, the PBoC is still likely to cut reserve requirement ratio for the whole banking system in Q3.

The ANZ has been calling for an RRR cut since the growth slowdown began in late 2011. If it comes it will mean it’s panic stations at the PBOC. The central bank is obviously allowing the interbank market to tighten because it does not want another round of runaway credit emanating from banks.

That’s the interpretation offered by Lombard Street, also from FTAlphaville:

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We have argued that Beijing needs to allow more defaults – and not easy ones – to convince the market that it is serious about changing the rules of the game in the economy and clearing up past excesses. In this sense the rescue of Huatong Bridge & Road Group Co., a private firm with close ties to its local government, has been a disappointment. It is reported that Huatong averted default with the help of the local government.

The blows to the reform agenda do not stop here. The authorities also announced a change in the method of calculating banks’ loans-to-deposits ratio, aimed at stimulating credit to small and medium-sized enterprises (SMEs). We have viewed the People’s Bank of China’s efforts to inject liquidity into the interbank market as an attempt to smooth the difficult adjustment that lenders need to go through as they return wealth management products to their balance sheets and as capital inflows turn to outflows. But a policy aimed at boosting bank credit is unwelcome, especially as the authorities have yet to launch universal deposit insurance. Such a scheme is crucial if private banks, now allowed, are to have a chance of survival. Private banks are primed to fill the gap of lending to SMEs. The delay in rolling out deposit insurance despite reports that draft legislation is ready, is not encouraging.

One could add to the list the “mini-stimulus” ordered by Beijing to put a floor under real GDP growth, which obligingly ticked higher in Q2. But as my colleague Freya Beamish has written, the surprise is how “mini” the stimulus has actually been. The main prop for growth in Q2 came from the external sector and not from surging domestic demand. Official support has been muted and is unlikely to stretch much far.

This could be interpreted positively for the reform drive. But the more sinister explanation is that the authorities are unable to provide a significant boost to growth even if they want to. They may be trying to boost credit to SMEs, but demand for loans has come off again. China needs to clean up after its debt binge, not stoke it further. The current level of debt may just about mean that Beijing has a chance to reform successfully even if that will involve a few years of meagre growth and financial distress. But the ongoing rapid rate of increase in debt suggests that policymakers do not have too long to postpone much-needed defaults…

Yes, the bailouts suggest a rollback of reform but the stimulus too date has been modest, especially so given the risks, from Ifeng via Investing in Chinese Stocks:

Ni Pengfei, Director of the Urban and Real Estate Economy Research at the Chinese Academy of Social Sciences (CASS) and also the Director of Center for Cities and Competitiveness, says a collapse in some eastern second and third-tier cities is “entirely possible,” though a national collapse is unlikely. Another researcher said housing demand won’t peak until between 2020 and 2025.

Ni also said the lifting of buying restrictions would have little effect, though he said first-tier cities such as Beijing and Shanghai would not lift restrictions because a lot of speculative money would come into the markets there, wiping out years of efforts to limit price increases.

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There is also the increasingly intense anti-corruption push that has claimed its biggest tiger, from the FT:

The most senior official to face corruption charges in the history of modern China has been formally placed under investigation by the ruling Communist party, nearly eight months after he and his family members were detained.

In a one-line statement published by Chinese state media on Tuesday evening, the party’s Central Committee announced it would investigate Zhou Yongkang, 71, the country’s former security tsar, for suspected “serious violations of [party] discipline,” a euphemism for corruption charges.

Between 2007 and 2012, Mr Zhou was one of China’s nine most powerful men as a member of the party’s Central Politburo Standing Committee, the pinnacle of power in the authoritarian state.

This clearly supports the notion that the reform agenda is moving forward hand-in-hand with a centralisation of power to roll back the vested interests.

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The base case remains that China has one foot simultaneously on the brake and accelerator, that reform is still firmly in control, and that after the current round of stabilised growth, the economy will slow again by year end.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.