Reflation Troubles

China’s stock markets have dominated the news recently, but the main risks for H2 2015 growth prospects are the headwinds to Beijing’s stimulus policies.  Q2 GDP came in on target, running at 7% growth overall.  But, the industrial component, important to commodity demand and China's economic passthrough to other economies, slowed meaningfully to 6.1%.

There are two main factors that could keep growth at or above the 7% target and boost the industrial sector portion of GDP in the second half of 2015: An improved property market (property has dragged down growth over the last year), and Beijing’s fiscal and monetary stimulus measures.

Property has improved significantly in the short-term (See my posting "Quick Data Update: Rebound in house prices, as sales grow over 16% on the year.") but Beijing’s stimulative policies have not followed the same patterns of previous years.  On the monetary front, we have not seen investment or credit growth meaningfully rebound months after easing measures were taken.  On the fiscal front, a planned fiscal expansion has yet to materialize. Government expenditures have grown below trend.  Headwinds to stimulus measure increase the risk of H2 2015 growth running below the target.

Top three risks to Beijing’s stimulus measures to watch out for:

  • The PBOC has been easing, but policy is still relatively restrictive, especially when compared with easing cycles during past economic slowdowns (see charts on the right).  Beijing is trying to follow two distinct policies, reflate short term growth, and force restructuring to rein in easing measure excesses from past years.  The RRR is still elevated, and real rates are still quite high.  The good news is that the PBOC has more room to broadly ease.  The bad news is that the timid easing so far has not been enough to kickstart activity with the same effectiveness as seen in years past.
  • Anti-corruption fighting has slowed the speed at which money is deployed.  A crackdown on lavish spending and greater scrutiny of local leaders means a much slower flow of government investment deployment than in the past.  There are repercussions to overspending on projects, and local leaders are probably playing it much safer than the free-for-all spending days of Wen and Hu.
  • Even as rates go lower and more money is freed up for lending by RRR cuts, mechanisms that once led from easing to fast credit growth have been inhibited in the last few years.  NPLs are rising and banks may have less of a stomach for a sizable upswing in lending. Overall credit has been slowed by Beijing’s attempts to rein in trust loans, wealth management products, and other non-traditional financial intermediary channels.  This has limited some of the mechanisms that allowed the PBOC to boost growth via easing in the past.

June certainly looks like a better month than early Q2.  Some sectors are improving.  I still hold the view that Beijing will reflate growth in H2, but there are risks that may delay or diminish policymakers' efforts we need to keep an eye on.