The People’s Bank of China’s decision to cut the reserve ratio requirement for banks – for the first time since 2008 – came a day before figures showed manufacturing activity had contracted for the first time in almost three years.
With the market now poised for a deceleration in economic growth, the nation’s stocks endured some of their steepest declines in several months as the news emerged.
In recent weeks, signs that inflation has peaked triggered hopes that Chinese authorities would embark on a stimulus effort (in the form of fiscal and monetary easing) to boost growth.
Last week’s RRR cut appears to support these expectations but we think markets are set to be disappointed by the pace at which this exercise unfolds. We expect a degree of stop-go policies over the coming months, which are unlikely to have a meaningful impact on economic development.
If, however, we are wrong and China’s authorities introduce a major fiscal and monetary stimulus, we would be very concerned about the economic impact of this, given the froth of credit and inflation already in the system.
Our overall view is that China has reached the limit of its current growth model – surplus rural labour has mostly been absorbed, demographics are now negative (shrinking workforce) and years of unprecedented capital expenditure mean the efficiency of capital is now falling sharply.
Although a recent slowdown in the rate of inflation boosted investor sentiment, we find the fixation of the market on China’s – largely bogus – official consumer price index of heavily price-controlled goods (which fell from 6.1 per cent to 5.5 per cent in October) extremely misplaced.
It is clear that, looking at other statistics, China remains on the verge of overheating.
Rather than the official CPI, investors should pay closer attention to some of the other statistics released recently in China.
Fixed-asset investment in September continued to outstrip nominal GDP growth, highlighting the fact that the investment bubble remains alive and well despite the supposed tightening of credit.
The recent RRR cut comes despite retail sales (year on year) in September clipping along at a 17.2 per cent, industrial production rising at 13.2 per cent and residential real estate investment up 27.5 per cent. All this indicates that the country’s much touted economic slowdown may be a case of hope over reality.
China has probably reached a crunch point, in our view – a time of great risk and opportunity – and minor tweaks in RRR rates are unlikely to have much impact.
The country desperately needs to move towards an environment of market-driven interest rates and a more flexible foreign-exchange regime. After a period of pain, this would allow the economy to rebalance and move to a healthier consumerdriven model.
Robin Parbrook is head of Asian equities at Schroders