- Stabilisation en route to modest growth
- Limited central bank support
- Market outlook somewhat cheery
Recent economic data shows signs of stabilisation. However, we believe downside risks remain amid a lack of pricing power. This most likely reflects weak business confidence as manifested in companies’ unwillingness to restock inventories despite stronger demand.
More broadly, liquidity has yet to recover sustainably. M1 money supply and my estimate of free liquidity have remained in the doldrums since 2Q 2019 (see exhibit 1). Selective monetary policy easing has been able to prevent only a liquidity contraction, but it has failed to engineer a robust, self-sustaining economic upturn.
Exhibit 1: Liquidity has yet to bounce back (YoY, %)
Source: CEIC, BNPP AM (Asia)
Modest growth, modest inflation
The recent pick-up in CPI inflation on the back of pork price inflation over the swine flu has dragged down free liquidity as well. Since food prices – pork is a significant component – have a more crucial weight in the CPI basket of developing economies such as China than in developed economies, surging food prices will likely weigh on consumer spending and, hence, GDP growth.
So the economic recovery is likely to be modest, with core (ex food) consumer, and producer, price inflation pinned to the floor. I expect GDP to grow by 6.1% YoY in 2020.
Further selective easing measures
Given the central bank’s low-profile approach of adjusting liquidity and interest rates via the money market, I expect more selective monetary policy easing measures going into 1Q 2020: three to four 5bp cuts in the MLF lending facility rate, the reverse repo rate and the LPR loan prime rate, and 50-100bp cuts in the reserve requirement ratio.
Currently, money market rates are not an important channel for system-wide credit as Chinese banks source most of their funding from retail deposits. Also, not all banks in the system benefit from MLF injections and rate cuts as the central bank controls the liquidity allocation from the MLF, limiting it to only a designated group of banks, and directs MLF liquidity recipient banks to fund specific investments.
Thus, policy easing via the money market is actually easing without significant systemic effects. Such moves signal to the market that Beijing is not seeking massive reflation.
Has China entered a rate-cut cycle?
Perhaps not. Firstly, because the central bank aims to keep M2 money supply growth at the same pace as nominal GDP growth, and M2 growth is now slightly ahead of nominal GDP growth (see exhibit 2). So, there is no urgency for significant easing.
Exhibit 2: M2 growth is outpacing GDP growth (%)
Source: CEIC, BNPP AM (Asia)
Secondly, CPI inflation has risen to over 3% –above the central bank’s target – thanks to soaring pork prices. Granted, core CPI is still below 2%. However, as the economy is expected to stabilise and even recover soon, concern about broadening inflationary pressures could become more prominent.
Thirdly, there is a systemic stability constraint on rate cuts. It has become a top priority for banks to raise capital, especially under-capitalised small and medium-sized banks. A few small banks have failed already. It would be hard for them to attract capital if declining lending rates hit their earnings.
Lastly, from a long-term reform perspective, the real lending rate is already low. Few countries have a prime lending rate that is 300-350bp lower than nominal GDP growth. Furthermore, the real LPR is approaching zero with CPI rising. So if the real lending rate is cut too low, it could backfire on the government’s debt reduction and structural reform efforts by allowing ‘zombie firms’ to survive.
Mildly positive outlook for assets
Summing up, barring any significant domestic credit events and escalation in the trade war, the macroeconomic environment should be mildly positive for Chinese assets in the coming year. Selective policy easing implies bond yields may be close to the bottom in the coming months.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
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