China is in trouble

New loans and M2 growth in July surprised to the upside, dominated by one-off measures to stabilise the stock market. RMB new loans totalled CNY1480bn in July, almost double expectations (consensus: CNY750bn, Barclays: CNY790bn). However, more than half of the new loans (CNY886bn from CNY-47bn in June) were extended to non-banking financial institutions, while household loans and non financial institutions loans both shrank to CNY275bn and CNY313bn, respectively (June: CNY458bn, and CNY860bn). This reflects the government’s stock market support measures in the past month, with bank lending to securities corporations soaring. As a result, broad money (M2) growth jumped to 13.3% y/y from 11.8% previously, while base money (M0) growth remained flat at 2.9% y/y. At the same time, the CNY loan balance growth was up notably at 15.5% y/y, from 13.4% in June.

Overall, the strengthening of loan growth reflects China’s efforts to halt the stock market rout, hence, it could be short-lived, in our view. Loans to the real economy remain weak, suggesting modest domestic demand, which is consistent with our baseline growth forecast. We believe stabilising growth and channeling low-cost financing to the real economy will remain top priorities for monetary policy in H2 2015. That said, we maintain our view of one more benchmark rate cut of 25bp in Q3, accompanied by a removal of the deposit rate ceiling, and look for one or two 50bp RRR cuts in H2 2015, depending on liquidity conditions.

Not good at all.

Meanwhile, from Zero Hedge comes a summary of the sell side take on the sudden China devaluation:

– MK Tang, Goldman Sachs

 The People’s Bank of China shocked the market today by weakening the yuan reference rate in the largest single-day depreciation since the central bank’s exchange rate reform on July 21, 2005. The PBOC statement interprets the depreciation as a one-off adjustment to fix the persistent discrepancy between the reference rate and the actual spot rate in the market. Since June, the yuan/dollar spot has been consistently about 1.5% higher than the daily fixing. The PBOC statement said that today’s adjustment will fix the discrepancy, and going forward daily fixing will align more closely with the closing spot rate on the previous day. The strong appreciation of the yuan has put a lot of pressure on China’s exports. It is unlikely that China will achieve the 6% trade growth target set for this year. Today’s announcement is also a response to weakening currencies around the Asian region.

– Haibin Zhu, JPMorgan

The PBOC was hitting two birds with one stone: The PBOC’s move will lead to a weaker yuan, lending support to export growth. It will also make the yuan exchange rate more market-determined, which could help China at the upcoming Special Drawing Rights review in November. In the past, one major problem with the yuan exchange rate setting was too much emphasis on its stability against the U.S. dollar while neglecting [trends in] other currencies. In the past 12 months, the yuan appreciated by 23% against the euro and 17% against the yen. As a result, so far this year, China’s exports to the EU and Japan are down 4% and 11% year on year. Today’s change should mitigate the problem. –Larry Hu, Macquarie Securities

We believe the unexpected devaluation today is more about the Special Drawing Rights bid rather than an intention to support exports. Tomorrow’s fixing will be the key to test whether this devaluation of fixing is one-off event or a start of new fixing system. Our best guess is that it may be a one-off adjustment. Should it prove to be a one-off event, we think a combination of a widening of the yuan’s daily trading band and a cut in the bank reserve requirement ratio is likely to be the next policy option to increase the yuan’s flexibility. In the near term,
we may see more volatility ahead.

– Tommy Xie Dongming, OCBC

We think it unlikely that the Chinese government will let only market momentum drive the yuan exchange rate from now on, as that can be quite destabilizing. We think the government may still want to take a relatively cautious approach on the exchange rate front. The upcoming SDR review is one consideration, and avoiding destabilizing depreciation expectations and capital outflows would be a more important one. In this context , how China sets its daily fixing and manages foreign exchange market flows in the next few days will be very telling. Nevertheless, we do see today’s move an important change in China’s way of managing the exchange rate.

– Wang Tao and Donna Kwok, UBS

The People’s Bank of China is finally acknowledging that the yuan has appreciated excessively in real effective terms, given the sharp depreciation of the euro and the yen. Such real exchange rate appreciation is clearly one of the key reasons for the extremely weak July export data published last weekend and must have pushed the PBOC to use one of its most powerful instruments to reboot the Chinese economy: the exchange rate. China has been losing competitiveness in third markets in an aggressive way. However, we believe that the PBOC will not dare let the yuan depreciate too rapidly or too aggressively. Moderate capital outflows have been the norm during the last few months to the point that China has nearly $350 billion less in foreign exchange reserves from a peak of $3.99 trillion. A rapid yuan depreciation would only feed additional capital outflows, putting additional pressure on the PBOC.

– Alicia Garcia Herrero, Natixis

The central bank has described this as a way to help exporters and said it is a one-off move. But that puts the central bank’s credibility on the line. The risk is that the move isn’t large enough. I don’t think the 2% adjustment does very much.

– Andrew Polk, Conference Board economist

I agree with UBS but if China does embark on sustained devaluation it will be terrible for seaborne commodities as it favours local production. Any way you cut it, combine the devaluation with the July credit data, the weekend trade and inflation data, the weakening PMIs, the panicked stock market save, a bifurcated housing recovery and the failure to gain traction with a year of targeted stimulus and what you get is a picture of a structural adjustment under intensifying strain.

China is in trouble.