Beijing is clearly getting nervous about the pace of growth in the world’s second-largest economy. In October we outlined how deteriorating economic data and falling property prices were weighing on China’s growth outlook and that more stimulus was needed to support the economy. Since then the PBoC has cut rates, which hasn’t had the desired effect, thus the market is now mulling over the idea of a possible cut to the Reserve Requirement Ratio (RRR), a move which seemed fairly unlikely just a few months ago. This week the release of more important economic data will provide us with further insight into what is happening in the world’s second-largest economy.
The PBoC cuts rates
Last month, China’s central bank cut its one-year lending rate by 40 bps to 5.6% and its one-year saving rate to 2.75% from 3.00%. This suggests to the market that Beijing is concerned about the health of the economy as it struggles with unimpressive levels of economic activity and falling property prices. Over the last few months economic indicators from within China have consistently come in below expectations, with key manufacturing and industrial productions figures showing weakness in the heart of the economy at the same time as other figures cast doubt over the strength of domestic demand. All of which is set against a backdrop of falling property prices--property investment makes up a significant chunk of GDP.
Beijing is saying that this latest move to boost growth doesn’t signal a change of policy, but it’s definitely a more aggressive stance than we have seen recently from policy makers. In recent months the PBoC has been using targeted stimulus measures in an attempt to promote economic activity, whereas this most recent move was theoretically supposed to have more of a wide-reaching impact and it signaled that Beijing has lost some faith in the ability of targeted stimulus to spur economic growth.
These moves aren’t having the desired impact.
Immediately after the PBoC cut interest rates, we postulated that it wouldn’t by successful in reducing borrowing costs or spurring economic growth. Along with the aforementioned rate cuts, the PBoC also increased the amount by which individual banks can set their own deposit rates above the benchmark. Banks can now set their own rate 20% higher than the ‘official’ rate as opposed to the prior 10% limit. This move is designed to encourage competition between banks for funding as part of the PBoC’s overall goal of achieving full deregulation of deposit rates. Yet, it will also squeeze profit margins, putting pressure on lenders. At the same time, the interest rate cuts haven’t succeeded in reducing borrowing costs (interbank rates have actually risen post-cuts which suggests that liquidity is tight).
Is more stimulus on its way?
Given the ineffectiveness of the first interest rate cut in two years and the threats to growth (the fear that headline GDP may dip below 7% from the current 7.3% rate) and the PBoC’s apparent willingness to pull out its big guns, we believe the bank may cut interest rates again or even the RRR – the latter would complement the drop in the benchmark rate and would be more successful in stimulating the economy in our opinion. In saying that, this outlook is largely data-dependent, which is where this week’s inflation and industrial production numbers come into the equation.
The current outlook for domestic demand isn’t looking good, especially given recent soft import data, stagnant inflation numbers and persistent disinflation in producer prices. Consumer prices rose 1.6% y/y in October, matching estimates and the prior month’s figures, and the pace of inflation isn’t expected to have changed in November (the data is due out on the 10th at 1:30 GMT). This is the slowest level of consumer price growth in five years and gave the PBoC the room it needed to cut interest rates later in the month.
Meanwhile factory-gate prices fell more than expected at -2.2% in October and November’s numbers are expected to be even worse (PPI is expected to fall 2.4% y/y) - producer prices have now been in disinflationary territory since the beginning of 2012. It’s worth noting that some economists believe that disinflationary pressures appear to be easing, which when combined with strong wage growth means that the market can brush off soft PPI numbers. However, investors cannot brush aside these soft numbers forever.