China: caution looks prudent but there are presently no grounds for panic
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China’s HSBC Purchasing Managers’ Index (PMI) for May’s new orders fell slightly, and this caused some concern for markets, but the HSBC PMI numbers are consistent with roughly 8% GDP growth.
Arguably of greater concern is the deterioration in the money supply data, which point to weaker growth trends.
As a first observation on money supply, deposit growth is at series-low (with data starting in 1998), and this threatens a higher real cost of deposits both to stem capital outflows from China and also to raise deposits. Slowing deposit growth also points to a higher real cost of capital, and as the real cost of capital rises, so the investment share of GDP is likely to peak. Looking for evidence from other economies that had enjoyed strong growth, with both Japan and Korea, GDP growth slowed significantly in the decade after the investment share of GDP peaked.
Turning to actual money supply data, there has been an historic link between so-called M1 and M2 measures of money supply and growth rates. Basically M1 is a measure of cash, and M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds, and the current ratio of M1 to M2 growth points to much weaker growth. New loans were only Rmb682bn in April after an average of Rmb820bn in Q1, despite many signs that the authorities were easing policy in April.
There are other concerns that suggest that we should be cautious. For example, the latest industrial production and electricity output data are consistent with 7% GDP growth (although 3-month averages are less weak) and this is potentially tricky not only because it suggests that growth trends are weakening but also because falling producer prices are pointing to a squeeze on margins and the range of forecasts of analysts are for GDP for 2013 are in a narrow range of 7.5–9%. This leaves room for disappointment and adverse reaction. Meanwhile there are other real economy factors which could adversely affect sentiment. For example, house prices remain high and 15% of the current stock is vacant. This suggests that house prices could fall by more than another 10%.
In the event of weaker growth, we might reasonably expect a policy response, but this might be less and later than many expect. As a big picture issue, over the next decade rural to urban migration is meant to fall to be around 80% lower than the last decade, and the population peaks in 2014 and the labour force peaks in 2018. This suggests that lower growth is on the agenda and the 12th Five Year Plan only ever sought 7% annual real GDP growth. As a more practical challenge, seven out of the nine members of the Politburo Standing Committee are due to be replaced this year, and therefore any major stimulus pursued in principle might only occur once government officials have been allotted their positions.
There seem to be no grounds for panic and 8% GDP growth this year is achievable with the fall in inflation potentially permitting more policy stimulus. But the trends are worrying and need to be monitored carefully and this is not an environment in which big risks look prudent. In particular it would seem sensible to be wary of exposure to companies dependent on strong capital goods order flows and rampant industrial growth. This may include the mining sector, which has recently benefited from downgrades to capital expenditure estimates, near-term policy measures in China and the fact that mining has significantly underperformed other China plays. Certainly in areas that may be more resilient such as branded consumer goods, the indirect plays look better placed than the direct investment opportunities.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
