No flood stimulus in China

Pantheon with the note.

Chinese Profits Under Pressure, and Stimulus is Still Lacking

Reopening in May provided a boost to Chinese industrial production, but industrial profits continued to fall. The pace of decline moderated, but we expect profits to remain under pressure for most of the year, amidst weak demand and probable further zero-Covid lockdowns. Local governments have already been ordered to ramp up efforts to cut costs for businesses, and such supply-side policies will be extended further in Q3 and Q4.

Total industrial profits fell 6.5% year-over-year in May, slightly better than the drop of 8.5% in April. The headline, however, masks a split between the private and SOE sectors. Private sector profits fell by 4.2%, an improvement from the 7.6% drop in April, while in the SOE sector, cashflow problems intensified.

Profits fell 11.4% year-over-year, from -2.9% in April. Monthly data tell a similar story. Private sector industrial profits rose 1.8% month-on-month, seasonally adjusted, after a 6.2% fall in April, while SOE profits fell 3.3%, from -2.4%.

The better performance of the private sector likely reflects two dynamics. The first is that SOEs were less likely to be subject to factory closures during zero-Covid lockdowns, as many qualify as “essential” industries. Consequently, SOE profits received less of a reopening boost. The second factor is that private sector firms, particularly SMEs, have been the target of increasing amounts of local government support, some of which will increase profits by reducing costs.

We suspect some SOEs also saw pressure to assist here by providing inputs at a reduced cost.

Reopening is not yet complete, so profits should find some more support in June. But the steeper drop in SOE profits suggests other problems plague Chinese industry. Considered by industry, profit growth improved most notably for manufacturers of some forms of machinery, communications equipment, energy suppliers, and some, but not all, consumer goods. This echoes the pattern seen in industrial production, with reopening—and export backlogs—supporting some industries more than others. Profit growth fell sharply in some cases, however, particularly coal—where profit growth nearly halved to 120.8% year-over-year, from 227.5%—ferrous metals, furniture, and a subset of non-durable consumer goods. Again, this suggests pressure on upstream industries to reduce costs for their downstream counterparts. But it also reflects continued weak demand by both construction and consumers, an issue not addressed by stimulus.

The demand outlook remains soft, and is reflected in weak core CPI inflation. The resultant gap between PPI and CPI inflation implies pressure on profit margins, and provides little hope of a recovery this year, as shown in our chart above. More support will be needed for firms, and supply-side stimulus is not going to cut it. Tax and fee cuts may keep firms on their feet, but they do not boost demand or sales.

Manufacturing FAI is unlikely to revive as long as the government sticks to its current policy settings.

The PBoC acts, but don’t get too excited

After a protracted period of inaction, the PBoC has begun adding liquidity to markets in recent days, injecting RMB 50B on Friday, and RMB 90B on Monday. The central bank has withdrawn liquidity each month since February, so this bears watching.

But we think it probably reflects quarterly liquidity needs, rather than a change in policy stance. It is highly likely that the new liquidity will be withdrawn in early July. The PBoC is still steering clear of aggressive action.

Governor Yi Gang, speaking on Monday, said that the bank would support the economic recovery with monetary policy in an “aggregate sense”, and noted that real rates in China were quite low. We see this as a signal that the PBoC thinks monetary policy is sufficiently easy, for the time being. Net liquidity injections therefore are unlikely to rise further, without a more decisive prompt from the central government.

Even then, such prompts seem less powerful than they once were. The PBoC very begrudgingly provided a 25bp RRR cut after strong hints from central government officials earlier this year, rather than the 50bp move suggested by past interactions.

Investors would be wise not to pin their hopes on any sudden surge in monetary or financial stimulus. The heavy lifting needs to be done by fiscal policy.

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