Tuesday, April 8, 2014

Will The 'Mini Stimulus' Save China's Sputtering Economy?

By IG Australia

Fresh worries on Chinese manufacturing industry contractions have been sparked by the announcement that the final HSBC Manufacturing Purchasing Managers’ Index (PMI) reading has fallen to an eight month low in in March. The HSBC PMI fell to 48 from February’s level of 48.5. At the same time, the China Manufacturing Output Index signalled a reduced amount of output in China’s manufacturing sector during March. Production levels have now declined for two consecutive months. Furthermore, the rate of contraction quickened from February to a moderate pace that was the strongest since November 2011. Business conditions have deteriorated for three months in a row now.

A level of 50 indicates that there has been no change on the previous month, seasonally adjusted, and the Chinese Manufacturing data has been below this level since January, which indicates a contraction in the sector this year.

The HSBC China Report on Manufacturing is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 420 manufacturing companies. The panel is stratified geographically and by Standard Industrial Classification (SIC) group, based on industry contribution to Chinese GDP.

The Chief Economist for China at HSBC, Hongbin Qu, said 

“The final reading of the HSBC China Manufacturing PMI in March confirmed the weakness of domestic demand conditions. This implies that 1Q GDP growth is likely to have fallen below the annual growth target of 7.5%. We expect Beijing to fine-tune policy sooner rather than later to stabilise growth.”

In conflict with the HSBC data, the official Chinese PMI level was 50.3, a slight increase on the previous month’s figure of 50.2, and the first rise since November 2013. The PMI figure for large enterprises was 51.0, which offset the lower figures of 49.2 and 49.3 for medium and small businesses respectively, which represent a contraction for these smaller sized manufacturers. However it should be said that the official data has a far larger sample size (3000 vs 420) that could provide a broader and clearer picture and representation of economic conditions, but its focus on larger, state-owned enterprises can and does skew the picture somewhat. Regardless, while the official stats paint a more positive picture than the HSBC data, it is certainly far from breath-taking and will do little to alleviate lingering concerns over the world’s second-largest economy.

With this in mind, expectations were high that the Chinese government would unleash stimulus measures in order to support growth. On March 26th Premier Li Keqiang said that the necessary policies were already in place and that the government would push ahead with infrastructure investment.

And indeed that is exactly what they did. On April 2nd, China unveiled a mini-stimulus package aimed at maintaining economic growth at or around the 7.5% target level. There has been some debate as to what this announcement really means, however. It is certainly far from the gargantuan 4 trillion yuan stimulus package pushed out in 2008 to counter the impact of the global financial crisis, but it is still seen as a move to re-iterate the President’s assertion that China’s government is ready, willing and able to enact policy to boost the nation’s flagging economy.

Before we analyse the importance and potential impact of this mini-stimulus it is worth clarifying what it entails, exactly. China’s State Council unveiled a combination of measures, namely the stepping up of spending on railways, upgrades to housing for low-income households and tax relief for small businesses. While this sounds like a relatively sizable intervention, it is well worth noting that these are largely policies and plans that were already in place and which are now merely being pushed forward or expanded slightly. The railway projects are simply accelerated existing, approved projects, and the tax relief is just a relaxation of criteria for a scheme allowing companies to halve their income taxes.

There have been decent rallies in Chinese equities on the back of the news, with China’s benchmark index rising to a six week high, amid speculation that this mini-stimulus is just the first of many such measures to be enacted. Energy companies were big winners, as China Petroleum & Chemical Corp., Asia’s largest refiner, rallied 2 percent.

It is however highly debatable whether this will do anything to reverse or even halt the decline of the world’s second largest economy. At a time when the country is labouring under a debt-to-GDP ratio in the region of 300%, when we have seen the first ever defaults on a junk bond and a corporate bond, and a run on a small bank (prophetically predicted by none other than Fang Xinghai, a bureau director at the Central Leading Group for Financial and Economic Affairs in November of last year when he said that China faces a “very high” risk of small bank failures) it is clear that there are deep problems facing the Chinese economy that small measures like this one have little chance of remedying.

It is increasingly apparent that there is a serious need for reform in the Chinese economy to take it towards a consumption-based growth model. Hongbin Qu and Junwei Sun, of HSBC said in response to the measures that they “should buy time to implement reform measures, which could involve some short-term pain.” In short, this “stimulus” is in effect a short-term stopgap to smooth GDP growth rather than another round of true stimulus, with economic reform necessary to stabilise the debt-laden Chinese economy in the long term.

Finally, while speculation was rife that incoming stimulus would boost demand for commodities such as copper, steel, cement, coal and iron ore on the back of infrastructural expansion, the news of only “mini-stimulus” has likely put an end to that ambition, if we believe that the Chinese government has set the tone of any future actions with this first announcement. In the absence of large scale infrastructure investment, the Chinese market is in a downward slope, and prices for commodities of which China is a major consumer could continue to be bearish.

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