China: The Dragon Has Been Tamed

by: Nikhil Gupta


China's Caixin PMI for March improved to 52.2.

Falling employment should worry the policy makers before the Q1 GDP data is released next week.

Structural reforms are the need of the hour.

China's Caixin/Markit services purchasing managers' index (PMI) for March improved from 51.2 in February to 52.2 in March helped by a rebound in the nation's service sector. On the downside, the composite employment figure dipped to 47.6, the lowest reading since 2009 and the 10 th straight month of contraction. A reading above 50 suggests an expansion on monthly basis while sub-50 indicates contraction.

These are mixed signals, at best, before the Q1 GDP report is released next week.

But, I believe that the Chinese economy currently lacks the strong foundation for its recovery. The fact that the employment numbers are dwindling, with companies' refraining from hiring new staff and are even downsizing due to muted growth expectations, suggests that CEOs are looking to survive the economic slowdown. Apart from blatant liquidity injection, the Chinese policymakers need to address the basic issues crippling the economy.

While the slowdown in domestic demand is limiting the growth potential, the rest of the world isn't providing much help either. IMF's Chief Christine Lagarde said yesterday that the global growth is weak and fragile and the risks on the horizon are increasing. Apart from some oil-importing nations, the rest of the world is battling a slump in energy prices as crude oil inventories continue to pile up. The oil freeze isn't expected to provide any help as the current production levels are at historic highs.

China's policymakers will likely prevent a hard landing even if the global scenario worsens. Going by the history (and their attitudes), their first option would be to pump huge liquidity in the system, but sadly, that also cannot hold the economy for long. These are temporary measures which can only buy time but not heal the economy.

Measures such as encouraging small, emerging industries can bring about the first round of demand growth. Slowdown in one sector can be managed by shifting the work force to another industry, and providing them with required skills. Asking mass recruiters such as Apple to improve the wages can also be the prudent move aimed at putting more money in the hands of people.

Additionally, China must put an end to its habit of overdoing things, even when there is absence of demand. For a simple explanation, China's housing market is a perfect example. When the nation's housing market was booming, rampant construction took place without heeding the principles of demand and supply leading to creation of ghost cities. The realtors who once pinned their hopes on rising real estate prices have till date been unable to sell their flats. China became a victim of greed.

The Dragon has been tamed, however, all is not lost. The policymakers need to quickly come in tune with the reality first before they commence their operations on the economy. Liquidity infusion can be a good tool but cannot replace strong, fundamental reforms. And they need to happen ASAP!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.