Kung Hei Fat Choy!
China released its latest economic data this week, and at first glance, inflation has picked up slightly, while international trade continues to struggle. At the same time, monetary supply and bank lending figures suggest that banks have become more accommodative. While these trends indicate that stabilisation of the economy could be underway, concerns of the leveraging nature of the economy and size of non-performing loans (NPLs) linger.
Inflation remained at a low level in January. The consumer price index (CPI) increased 1.8%YoY in January, higher than the 1.4%YoY annual average of 2015 (Chart 1). In line with the previous trend, food inflation (+4.1%YoY) remained the biggest contributor to consumer inflation, while non-food components in the CPI basket continued to see a mild increase during the month (+1.2%YoY). At the same time, producer price index (PPI) declined 5.3% in January, extending the streak of year-on-year decline to 47 straight months. The overall disinflationary environment suggests that domestic demand remains weak, while the PPI deflation points to underutilisation of certain production capacity.
The case of underutilization is confirmed by the weak export numbers. Exports declined at their fastest pace in 10 months, plummeting 11.2%YoY in January, compared to the 1.6%YoY decline in December 2015. China’s exports to G3 (EU, Japan, and the U.S.), accounting for 39.5% of the country’s exports in 2015, dropped 10.2%YoY in January, with exports to the European Union leading the decline (-12%YoY). While we expect the U.S. economy will continue to grow at a moderate pace with the largely accommodative monetary conditions, the general fragility of developing economies could become more of a concern for Chinese exporters, as well as the other economies which also faced drastic declines during the month, like Japan (-12.9%) and India (-13.6%).
Amidst the ongoing concerns of the Chinese economy, policymakers including Premier Li Keqiang and PBoC Governor Zhou Xiaochuan have become increasingly vocal in calming concerns. Indeed, the January data reflected policy direction as the banks were noticeably going on a lending spree. However, the increasing cases of bad loans and leverage imply that the Chinese policymakers are stuck between a rock and a hard place.
New RMB loans in January came in at some RMB2.51 trillion, the highest new RMB lending on record. Of this amount, new long-term loans extended to households (RMB478.3 billion) and enterprises (RMB1,060 billion) were the biggest contributors, which we believe is reflective of the Chinese government’s measures to support the housing market. By our estimates, bank lending to the real estate sector (i.e. including mortgage and development loans) has been climbing continuously, reaching 22.4% of the total loan portfolio as of the end of 2015. This number could reach 23% of total loans by the end of 2016 at the current pace of growth.
On a relevant note, M1 and M2 have risen 18.6%YoY and 14%YoY, respectively, in January. The high correlation between M1 and nominal GDP growth in the past decade suggests that the continuous acceleration of M1 growth would help boost the economy toward the second half of this year, which remains as a key assumption for our base-case scenario.
Nevertheless, while the easing monetary stance could help stimulate top-line economic growth, such trends will likely lead to more concerns about the leverage situation of the economy – which reached 221% of China’s GDP in 2015, up 12 percentage point from a year ago, by our estimates. Moreover, as NPL continues to pick up rapidly (i.e. +51.2%YoY in 2015) and NPL ratio reaches 1.67% (the highest level since 2009) such worries will likely underwhelm sentiment in the near term. Last but not least, the marginal impact of additional monetary measures on stimulating demand is doubtful, particularly when the interest rate has stayed low for over half a year.
Against such backdrop, policymakers may need to dig into their toolbox and come up with other tools – likely on the fiscal side – to rejuvenate the economy.
 Over the past ten years, if M1 led nominal GDP growth by three quarters, the correlation stood at 0.73. Noting that M1 growth accelerated to double-digit toward the end of 3Q2015, we expect stabilization of growth toward the end of 2Q2016.
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