The last couple of weeks have seen declining interbank rates and flat yields of our surveyed trust and bank wealth management products. This might be a signal of demand slowdown and that China's landing is going to be harder than anticipated.
This risk has been acknowledged and articulated by the government. At yesterday's State Council meeting, Premier Wen warned of new, unforeseen developments in the Chinese economy that threaten to retard China's growth.
This special brief presents evidence that the risk of weaker demand is rising, notably in the weakening trend of fixed asset investment.
- Looser monetary policies cannot explain the decrease in rates. Last week's RRR cut merely served to offset the lower forex inflow and its expansionary effects are negligible.
- Fixed asset investment, a key driver of Chinese GDP growth and to a large extend controllable by the government, is slowing down suggesting that weaker demand is to blame for the lower rates. The term structure of bank loans, used to gauge enterprises' long-term investment willingness, is becoming increasingly skewed towards shorter terms.
- Excess reserves at the PBOC are increasing, showing lack of opportunities for commercial banks to extend loans even though credit quotas are being expanded.
- The ChinaScope Financial Leading Economic Indicator (CSF LEI), which leads the economy by approximately four months, supports the proposition that China's economic landing may be harder than anticipated.
- While this is a nascent trend and it is too early to draw conclusions, we believe the potential implication of the current trend is comprehensive policy responses to maneuver towards a soft landing. Monetary policies will be insufficient and potentially detrimental in terms of higher inflation and loans directed to unproductive ends. Fiscal policies must step in, not only to keep the economy afloat but also to steer it in a more sustainable direction. Short term measures will be a speeding up of infrastructure construction, and long term responses will include SME support, liberalization of key sectors, and tax breaks to stimulate the private sector.
Decreasing Lending Rates Show Weak Demand for Money
Interbank lending rates have been declining since the onset of 2012 and their fall in recent weeks has become more rapid. Bank wealth management product rates, gathered through monthly CSF surveys of 1000 products and used as an indicator for market rates, are decreasing after climbing in the last couple of years.
The PBOC data show that the descent of deposit growth is accelerating, and that M2 growth decreased month-on-month in April. The 0.5 ppt RRR cut last week only served to offset the slower inflow of forex, and has negligible expansionary effect. The tight money supply paired with decreasing interest rates indicates weak demand for liquidity by the real economy.
Evidence of Weakening Demand is Becoming More Convincing
The fall in growth of fixed asset investment and rising proportion of short-term bank loans further support that the declining rates are due to a decrease in demand. As an indicator of the withering demand, fixed asset investment growth was 20.2% in April, down 0.7 ppt on March, pulled down by rapidly declining growth of real estate investment.
The composition of bank loans also reveal lackluster investment sentiment. The growth of medium and long term loans was 9.10% in April, compared with 23.64% in January 2011. Meanwhile, the growth of short-term loans and bill financing is increasing rapidly, showing that enterprises are taking out loans to meet short-term liquidity demand rather than to invest in long-term fixed asset projects. Falling demand is also evident in the wider context of China's financial system; total social financing decreased in year-on-year terms in 2012Q1.
Moreover, increasing amounts of excess reserves placed at the PBOC further supports the proposition that demand for money is less than supply, and that despite the more relaxed regulatory environment, banks cannot find enough opportunities to extend loans.
Weaker Demand Does not Bode Well for China's Economy
While weaker demand is merely a nascent trend, it is backed by long term tendencies. In the last two years fixed asset investment growth has been declining while market rates have been increasing due to inflation curbing monetary policies. It is, however, only recently that growth of market rates has stalled, giving concerns over the outlook of China's economy a greater and more resolute voice. The CSF leading Indicator, which is based on a series of macroeconomic indicators and leads the economy by approximately four months, is down to 95.33 in April compared to its peak of 125.94 in October 2009.
Based on the current outlook and the government statements the last couple of days, we are expecting firm policy responses to modulate the economy. Short term measures to provide immediate stimulus to the economy will include a step up in the development of infrastructure and possibly an increase in social housing development.
The real challenge for China's policy makers, however, lies in facilitating long term structural change, and the current market sentiment has made its solution all the more critical and urgent. We expect to see private sector tax cuts, stronger SME support and concerted efforts to increase domestic consumption in order to deal with the long term consequences of China's weaker demand.