China slowdown

China Crashes in April, Shows Signs of Contraction

Yesterday, the People’s Bank of China lowered the reserve requirement ratio by 50 basis points. Now, China’s banks will have an extra 400 billion yuan—about $63.5 billion—to lend.

Forbes,

13 May, 2012

It was the central bank’s third reduction in the ratio since November.  In April, new renminbi-denominated lending fell 8.2% from the same month last year and 32.6%—329.6 billion yuan—from this March.  In short, the amount freed up by yesterday’s action is just a little more than the decline in new lending last month.  As analysts noted, the cut in the ratio was too little and too late.  As a consequence, it will have little effect.

And in coming months, the effectiveness of the ratio cut will decrease because deposits are fleeing the Chinese banks, thereby reducing the amounts banks can lend.  In April, renminbi deposits fell by 465.6 billion yuan.  A year ago, they increased by 342.4 billion.

Beijing needs to do something fast.  New lending is considered the third-most reliable indicator of economic activity in China, so it’s apparent the economy is in distress.

That conclusion is confirmed by the most reliable indicator, electricity output, which last month grew by only 0.7% year-on-year.  Because the growth in electricity historically outpaces the growth of the underlying economy, the best China is doing at the moment is hovering around 0%.  In all likelihood, it is contracting.  And this is occurring when the Chinese economy almost always shows robust expansion.  In China’s export belt it is, after all, the beginning of the Christmas season.

Orders placed at the most recent session of the closely watched Canton Fair fell more than 4% from the October session.  As they said at the conclusion of the event a week ago, factories producing for Christmas are now feeling an “early winter.”

The chill is already being felt.  April’s trade surplus ballooned to $18.4 billion, up from $5.4 billion in March.  The surplus beat expectations of $10.4 billion, but the news was uniformly considered in a negative light.  For one thing, exports were up only 4.9%, and more important, imports increased by a miniscule 0.3%.  Analysts had expected exports to increase 8.5% and imports to soar 11%.

Imports showed weakness because consumers were not buying and because factories did not foresee the need for commodities for the meager orders on their books.

In April, the “up” numbers were below recent historical averages.  Factory output, for instance, rose 9.3%, far below expectations and March’s 11.9% gain.  Real estate investment grew 9.2%, the first single-digit increase since November 2009.  Fixed-asset investment in the first four months of this year rose 20.2%, the slowest pace since December 2002.

The only truly hopeful sign was bellwether car sales, up 12.5%.  That helped make up for a weak first quarter.  Car sales increased only 1.9% for the first four months, year-on-year.

Considering everything, Beijing will have to do more than reduce the reserve requirement ratio.  Analysts talk about a cut in lending rates, to make money not only more available but cheaper.  There are two problems with this maneuver, however.  First, China’s enterprises are not optimistic, so rates would have to drop substantially to make them look attractive.

Second, the banks would then have to reduce deposit rates, and China’s abused savers do not look like they are willing to accept much more punishment from the country’s central bankers.  In a sign that Chinese citizens are already unhappy, individual depositors withdrew 637.9 billion yuan from bank accounts last month.  So a reduction of deposit rates could trigger even more massive withdrawals, draining liquidity from state banks that would undoubtedly be considered insolvent if their assets were assessed according to international standards.

Other rescue strategies also have problems.  Printing more renminbi would reignite inflation, which is undoubtedly worse than the official 3.4% in April.

And then there is fiscal stimulus.  Unfortunately for Beijing, just about every bank and government financing vehicle is already stuffed to the gills with debt incurred as a result of the spending binge that Premier Wen Jiabao ordered at the end of 2008.

In an emergency, the premier will probably announce a new round of construction as well as business tax breaks and incentives for consumer purchases.  He has, to his credit, held off on doing so, but now he is presiding over an economy that is decelerating at breakneck speed.

His government has no good options.  So look for him to do something desperate—perhaps as early as this month—especially because he cannot risk a contraction during a year that is supposed to initiate an historic leadership change at the 18th Party Congress, scheduled for the fall.

As a practical matter, Premier Wen has no choice but to open the floodgates once again and, in some fashion, re-float the economy on a sea of newly printed renminbi.

More government money, however, will only postpone problems—and make them harder to solve in the long run.  That is the lesson from Wen’s last round of intervention in the economy.