With the Chinese economy seemingly in the midst of a fairly soft landing, global investors have not been paying much attention to China in recent months. However, all that will change as a result of the extremely weak Chinese activity data for April which were published last week. Asian equities and commodity prices have already fallen this quarter, and that will turn into a global problem if the April activity data are a harbinger of things to come.
The April data have not only shaken investors out of their earlier complacency, they have clearly affected policy makers too. The cut of 50 basis points in the banks’ reserve requirement ratio announced on Saturday suggests that the urgent need for a policy injection is at last being recognised. The question now is whether Chinese policy makers, in sharp contrast to their normally sure-footed behaviour, have left it too late to stem the downward momentum in the economy, and especially in the property sector.
Chinese economic data are, of course, notoriously unreliable and difficult to read. Most data are released in the form of 12-month percentage changes, which tend to obscure short-term variations in economic momentum. Seasonal adjustment is another severe problem, especially around the turn of the calendar year, when annual holidays massively distort the reports. Although the economics teams in several investment banks now publish their own estimates of monthly and quarterly changes in the most important series, these can differ markedly from each other, and are subject to huge revisions. Nevertheless, investors have no option but to attempt to peer through the fog.
The first graph shows my latest effort to make sense of recent data:
The weakness in official economic data in April is shown in the combined monthly activity indicator, which I have calculated from the key monthly series published by the official statisticians.
Growth in industrial production dropped in April to 9.3 per cent, close to the trough seen in the last recession in 2008, and this has been confirmed by similarly weak readings from electricity, cement and steel production. The sources of this weakness have encompassed both domestic demand and foreign trade sectors. In particular, fixed asset formation in the property sector, and export volume – the two main sources of growth prior to 2010 – have both shown sharply receding growth rates. The activity indicator has plummeted in April almost to match the depths recorded in late 2008.
However, as the graph shows, the economic data contrast with the official PMI business survey, which has risen strongly since the end of last year. Which set of evidence should we believe?
As regular readers of this blog will know, I usually give a great deal of weight (perhaps too much) to the PMI data and other business surveys. However, on this occasion, it is probably right to put more weight on the official data. Virtually all of the key official series have moved in the same downward direction in April, which is unusual. Furthermore, part of the rise in the PMI has probably occurred for seasonal reasons, and the rise in the official PMI has not been matched by a similar increase in the private sector version of the PMI published by Markit/HSBC. That series has been virtually flat since late 2011.
Overall, the April data look to be consistent with a decline in the rate of real GDP growth to somewhere in the region of 7.5 per cent, compared to the 8.1 per cent recorded in Q1. Since many forecasters had expected the first quarter to represent the trough in the current cycle, there is now likely to be a general downward revision to GDP forecasts for 2012. Growth of about 7.5 per cent is close to the likely trend rate of growth for China in the next 5 years, and it would not be a disaster. But markets are now likely to remain concerned until they see clear evidence that the growth rate has actually stopped declining.
The good news is that a significant easing in economic policy is now on the cards. Until recently, the fiscal and monetary levers have remained in restrictive settings, despite the slowdown in economic activity which began almost two years ago. Several factors were at work here. Inflation was a problem and, although that seems to have mainly stemmed from global commodity prices, Chinese demand for primary materials can clearly have a large impact on global prices. The large drop in producer prices seen in the last few months offers clear evidence that the worst is over on this front.
More importantly, the authorities recognised that a bubble needed to be addressed in the real estate sector, especially in residential investment. There was a belated acceptance that investment in that sector had become bloated and unsustainable, so regulations were tightened and the fiscal and monetary taps were turned off. There is now a danger that this adjustment has gone too far, and could develop into a hard landing. Regulations are now being relaxed, and the latest drop in reserve ratio requirements suggests that there is a renewed determination to raise the growth rate of bank lending.
The government also wished to promote a rebalancing of the economy between exports and consumption, so it has permitted the real exchange rate to rise by about 20 per cent in the past 5 years. With world trade growth falling in 2011, the export sector could not cope with this loss of competitiveness, and other Asian economies have been taking some of China’s share of world trade. Now that China’s trade surplus has almost entirely disappeared, it would be very surprising if any further rise in the real exchange rate will be tolerated.
Since 2010, China has been determined to reduce inflation, and to rebalance its economy. It has had some success in both objectives, but is now at risk of a hard landing. An aggressive policy easing is needed. It will certainly be forthcoming, and will arrive in the nick of time to head off a hard landing.
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