What is China Doing to Prop up its Economy?
Just days ago the Chinese premier Xi Jinping admitted that the leadership of his country is deeply worried about the economic slowdown that is taking place. However, Jinping chose his words carefully by referring to the contraction in the Chinese economy as ‘growing pains’ rather than alluding to the structural weaknesses of the world’s second-largest economy. Of course, Xi Jinping is referring to the pivot that has taken place in the strategic economic agenda: from export-driven growth to consumer-centric growth. The Chinese government realizes that its burgeoning middle class is a source of immeasurable wealth, prosperity and growth potential. To tap into that, the government has embarked upon a massive nationwide policy of infrastructure development by building urban complexes, upgrading roads, amenities, public works etc. This is a fiscal policy measure designed to stimulate economic growth within China, and it has to a large degree offset many of the negatives related to declining exports.
However this multistage strategy for China will take several years to be fully implemented, and in the interim we are seeing what Jinping describes as growing pains in the Chinese economy. The comments were made on the back of his official state visit to the United Kingdom, where he promises to bring billions of pounds in investment to the table. That the Chinese leader is focused on Britain as its European partner is significant. At a stage where the global economy is looking to China for stability, this new investment proposal will certainly bolster confidence over the long-term. The Chinese are seeking to shore up their economic juggernaut status by securing 150 deals with the UK in multiple sectors including energy, healthcare and aircraft manufacturing. This is all taking place against a backdrop of declining Chinese stock markets, emerging market currency crises, and a commodities price meltdown. China has traditionally been an economy with substantial foreign investment in it, but now the Chinese are looking to invest in other economies to maintain economic growth. Britain is being eyed as China’s #2 trading partner within a decade.
That the UK government is cosying up to China, and vice versa, has many human rights activists deeply concerned. However the Chinese leader considers these peripheral issues to be nothing more than awkward things, and prefers to focus on investment and trade-related issues. There are however many concerns about the quality of the products manufactured in China, such as relatively inexpensive Chinese steel. Problems aside, the Chinese have a vested interest in strong economic cooperation with the UK. As a case in point, sports collaboration between the two nations will be bolstered with the introduction of football to some 20,000 Chinese schools. That Britain is now eager to sign all manner of trade deals with China marks a sharp reversal from the days where Britain was the supreme power and China was subservient.
What does 6.9% Q3 growth figure mean for China?
For starters, this is the sharpest 3-month contraction since 2009. What is even more surprising is that this contraction took place even with rate cuts by the People’s Bank of China. In Q2, 2015 the GDP (YoY) grew by 7%, but the contraction has now resulted in the GDP falling below the key support level of 7%. This gives credence to the deep concerns that investors have about the state of the Chinese economy, given the July/August slump in equities markets. The 2% currency devaluation of the CNY was another such measure taken by the Chinese government to try and support their ailing stock market, and the manufacturing sector. However the biggest concern for the Chinese is the sharp decline in manufacturing output which sank to 5.7% during September, when analysts were forecasting a consensus estimate of 6%. This is especially notable given the 6.1% increase in August 2015. However, it’s not all doom and gloom for the Chinese economy given that retail sales increased by 10.9% and a 10.3% increase in fixed asset investment took place from January through September (YoY).
Now however, Beijing has decided to cut interest rates once again. This is the fifth time in 1 year that the government has adopted this monetary policy. Naturally, Asia-Pacific stock markets react with concern whenever the Chinese economy falters. Since China is such a major importer of the products and services of EM economies and other countries in the Asia-Pacific region, anxiety levels tend to increase. This has been reflected in persistently low commodities prices in copper, iron ore, coal, natural gas and oil. News of a rate cut in China was viewed positively by stock markets in that a rate cut is a means of expanding economic growth. By reducing the cost that investors, banks and consumers have to pay in interest rates, more personal disposable income and profits are available to everyone. This bodes well for stock markets around the world, but does precious little to support the CNY, or to inspire the confidence of foreign investors in the Chinese economy. The most important metrics released by China include the following:
- The year-to-date GDP for Q3 (YoY) – 6.9%
- Retail Sales year-on-year for September - 10 .9%
- Industrial production year-on-year for September - 5 .7%
The move to cut interest rates further is being perceived as one of the most significant ways to boost economic activity. Another available option to the Chinese government is a tax decrease. That the government believes China is in a transformational stage of its economic growth is important: this is the interim period – the transit station - between an export-driven model and a consumer-centric model. The veracity of any economic data emanating from China needs to be seriously questioned. Since everything is provided by the Communist government, and prestige means everything to them, it is unlikely that what we are seeing in the print media dovetails with the realities on the ground. Perhaps a more accurate assessment of the economic performance of the country would be found in alternative measures such as electricity consumption. Manufacturing in China has taken a huge hit, and this is evident in the declining export numbers from emerging market economies, plunging commodity prices and the domino effect that has rocked global markets. Structurally, there are many problems in China, including weak real estate prices and 20.4% declines in imports year-on-year for September. Not surprisingly, this helped China to achieve a trade surplus of $60.34 billion – but this good news has been offset by weakness in manufacturing.
Using a Rate Cut to Stimulate Economic Activity
On Friday, 23 October, the PBoC decided to step in and slash interest rates by 0.25% to 4.35%. The rate cut went into effect on Saturday 24 October, 2015. China has also decided to slash its 1-year deposit rate from 1.75% to 1.5%. Among others, the Chinese government is implementing a series of measures to reduce the amount of money that banks are required to hold in cash by 50 basis points so that banks will be encouraged to loan money to those who need it. The Chinese are also facing problems of another kind – massive capital outflows. This problem has been plaguing the Chinese economy for much of 2015, as the slowdown has been a long time in the making. As the price of Brent crude oil has weakened on global markets, it has had a contractionary effect on the inflation rates of Eurozone countries, China, Russia, the US and others. This has been one of the main drivers of quantitative easing programs by the European Central Bank and the People’s Bank of China. Unlike the EU and the US, China has plenty of wiggle room when it comes to reducing the 1-year lending rate. Countries like Japan are already at negative interest rates and the imposition of greater cuts is discouraging to investors who want to put their money in banks for safekeeping. This is precisely the reason why negative interest rates are a strong motivation to increase expenditure. Whenever rate cuts are announced, currency markets get anxious and stock markets rally. This is precisely what happened in the wake of China’s latest announcement!
