China will be mired in a period of ambiguous and unending reform until governments central and local bin the GDP targets that have forced the country to grow at excessive rates for more than a decade, Hu Shuli, the influential editor of business magazine Caixin, wrote in an editorial last month.
That day is a long way off. The central government has fixed a GDP target of 7.5% for this year and as economic data continue to disappoint and defaults emerge in sensitive sectors such as housing, chances are increasing that nervous policymakers will try to spend their way to reach that goal.
The tone for 2014 is strikingly similar to last year. At a meeting with provincial leaders last week, Premier Li Keqiang said economic growth must remain in an “appropriate zone,” which analysts have pegged at above 7% annual GDP growth. The phrasing is different but the significance is the same as Li’s “bottom line” in 2013, an undeclared floor believed to be 7% that couldn’t be fallen through.
It’s clear that ambitious reform will subdue GDP growth while rapid expansion will edge out hopes for restructuring the way China’s economy runs. How the premier will proceed to balance financial and market reforms with economic growth in the medium term is up for debate.
The likelihood this year of a major stimulus package on par with the US$589 billion monster in 2009 is low – practically impossible, some analysts say. Even if the government could muster the money this year, it would undermine all confidence in the reform promises made by China’s new leaders.
Beijing will no doubt engage in some “fine tuning” of the economy in 2014. The question now is what areas will be stimulated and what industries will feel the touch. In several places, efforts to pull the economy out of an early rut are already well underway.
The plunge
A year ago, China’s economy was dealing with a similar slowdown. By July of last year, after several months of mixed economic data, the government stepped in with several targeted stimulus boosts which helped push annual GDP growth past the official target to 7.7%. Fiscal measures focused on railways and renewable energy.
Things look much worse this year. The official purchasing managers index (PMI) rose to a reading 50.3 for March from 50.2 the month before, according to data released on Tuesday by the National Bureau of Statistics. A reading above 50 indicates economic expansion. The slight increase is encouraging but well below the average for March PMI readings in the past. ANZ Research noted that March readings have historically increased by an average of 2.8 percentage points due to seasonal factors.
This follows two months of troubling data. In February, exports plunged by more than 18% year-on-year. Retail sales fell to a 10-year low in the first two months. Factory output slowed to 8.6% year-on-year growth in January and February, down from 10% in the final quarter of 2013, the lowest reading since 2009. During that same time period, fixed-asset investment (FAI) declined to 17.9% from 18.3%. Residential sales and construction activity were deteriorating in late February.
Given this poor start to the year, analysts at many investment banks project 7.2% growth in the first quarter of the year, a sharp downturn from 7.7% in the la three months of 2013.
Hand in hand with the discouraging data are signs that defaults could snowball in the corporate sector, particularly among small firms in real estate and other glutted industries such as solar. China allowed its first onshore corporate bond default on March 7. Since then a steel firm and a developer have gone bottom up. Small city house prices are slowing or falling. Defaults could pop up at trust companies.
They’re already doing it
Investment banks are relieved that Premier Li has hinted at “fine tuning” China’s slowdown.
In fact, Beijing is already spending. Last month, it pointed to a few targets for stimulus when it released an urbanization plan. The document, engineered by Li himself, is a rough blueprint for urbanization through 2020, when the country aims to have 60% of its citizens residing in cities and towns. Li also said that China will spend some US$160 billion in the next seven years to build subsidized housing.
Part of this year’s stimulus could be an injection of money for affordable housing, Hao Zhou, a Shanghai-based economist at ANZ Bank, said on Monday. It could also go into the renovation of shanty towns, another item mentioned in the new plan.
“I think it will be very similar to last year’s,” Hao said of Beijing’s fiscal approach in 2014. Railways could be a major recipient of government funds. The urbanization plan calls for connecting many cities with rail lines with the hope of stimulating small, local economies. In mid-March the National Development and Reform Commission approved five new rail projects worth about US$23 billion. Last week, the NDRC approved a US$11 billion project for agricultural infrastructure.
State spending is already flowing into the economy; last year’s target stimulus wasn’t announced in a single statement or pushed through in one transaction. “This year could be the same,” Hao said. “The government could do something but not say it explicitly until there is some market panic. Then maybe they will inform officially. If there is no panic, they will probably maintain a low profile.”
Get selective
The People’s Bank of China seemed in line with the loose stance as well – at least until mid-March.
Last June, in an attempt to rein in shadow banking, the central bank raised the cost of borrowing substantially. Interbank rates stayed high through Chinese New Year then fell in what appeared to be new accommodation for lending. Seven-day repo rates hit a 20-month low in February.
The bank has tightened up a bit, however. The seven-day repo rate, a gauge of funding availability in the interbank market, has climbed back toward the average rate during the second half of 2013, 4.4%. The rate was 4.2% on Tuesday. “These are not the actions of policymakers gearing up for significant stimulus,” London-based Capital Economics said in a note today.
The overall cost of financing has stayed higher, despite the liquidity injections that tend to pull down the short-term costs of borrowing. Three-year AAA-rated corporate bonds have remained above 5% and investment bank Nomura noted last week that “Without a stronger signal from the PBOC, the market will likely continue to expect persistent deleveraging, and financing costs will remain high.”
Deleveraging was the original aim of the central bank when it pushed up borrowing costs last June. However, now it’s challenged with supporting real economic growth while in the same breath keeping shadow lending at bay.
“Looking at the interbank rates is going to give you a bias picture of the whole policy stance,” said Li Wei, a Shanghai-based analyst at Standard Chartered. The level of liquidity in the market is sufficient, he said, but banks have become increasingly cautious in their lending behavior and trust companies are struggling to sell their products. Despite the liquidity “you don’t have an active lending market to transfer the money to the end users. That’s where the problem is at the moment,” Li said.
March lending data isn’t out yet, but in February total social financing, or TSF, China’s widest measure of credit growth, fell to RMB939 billion (US$151 billion) from RMB1.7 trillion a year ago. A drop in non-bank lending, where shadow bankers get their funds, accounted for much of the decrease.
Distress at trust companies, small, highly leveraged corporations and private property companies has spooked lenders. Simply lowering the cost of lending won’t be enough to convince banks to issue more loans in the second quarter of the year.
“If growth continues to slow then PBOC will probably have t
o do more than just keeping low interbank rates,” Li said. “It needs to encourage banks to lend more. And of course the policymakers will emphasize that the lending needs to be selective.”
On the policy side, this is a much lighter touch than in the past. But major stimulus may not just be undesirable, it could be infeasible.
“The scale of the credit expansion over the past few years has been so large that delivering a renewed acceleration in credit growth would require increasingly implausible volumes of new lending,” GaveKal Dragonomics said in a report last week.
In 2014, “fine tuning” could be the government’s only option.
