China: Patchy Activity Keeps Policy Makers in Easing Mode
Summary: The latest read on Chinas manufacturing sector suggests nascent green shoots remain alive and economic activity, although patchy, is continuing to stabilise into the start of 2020. However, despite signs of stabilisation longer term structural pressures remain and activity levels remain precarious as the tariffs and hangover from the deleveraging drive take their toll on economic activity, which keeps policymakers in easing mode.
Both the official PMI and Caixin PMI remained in expansionary territory in December as the trade détente continues to support business sentiment, although the Caixin PMI was slightly less optimistic than the official data.
The Official PMI, which primarily tracks larger companies and state-owned enterprises, held steady at 50.2 according to data released by the National Bureau of Statistics, beating estimates of 50.1. The output, new orders, and new export orders sub-indices all rose, with new export orders rising above 50 for the first time since June 2018, indicating a potential improvement in both global and domestic demand as sentiment is boosted by the phase 1 trade accord and potential stabilisation in global growth as central banks have stepped up monetary easing.
The Caixin Manufacturing Purchasing Managers’ Index, which primarily tracks small companies and is more balanced toward the private sector, slowed marginally to 51.5, down from last month’s 3 year high of 51.8, narrowly missing estimates of 51.6. Because the Caixin PMI tracks smaller firms, it is much more volatile and more prone to seasonal effects. The Caixin PMI new export orders sub-index expanded only slightly, as the Caixin PMI tends to be more skewed towards export oriented firms it may be providing the truer representation of external pressures as global demand continues to suffer despite the acclaimed trade deal.
Of concern, the employment sub-component of the official PMI remains in contractionary territory below 50, as it has been for 33 consecutive months. The employment index within the Caixin PMI (which is more skewed to the private sector) fell from last month and is only just above contractionary territory. Cracks in the labour market concern policy makers in China, for whom it is crucial to maintain social stability and jobs growth likely keeping employment a policy priority throughout 2020. Small businesses also continue to be hit harder than larger firms, with the sub index for small firms remaining deep in contraction for 15 consecutive months now whilst large firms remained in expansion at 50.6. This is of concern because the private sector now contributes more than 80% of China’s employment and accounts for the majority of new jobs created each year. Signalling still that the pockets of the economy that need it, are not yet feeling the effects of stimulus measures. Hence why steps are being taken to reduce borrowing costs for smaller companies who often face higher interest rates than larger state-owned enterprises, a commitment that will be ongoing throughout the year ahead particularly whilst the growth stabilisation remains vulnerable.
On January 1st the PBOC cut the RRR by 50 bps, effective January 6. The move is expected to release RMB 800bn in base money liquidity ahead of Lunar New Year holiday squeeze, as well as reducing banks’ funding costs by RMB 15bn on an annual basis, helping to bring down financing costs for SMEs and private enterprises. Over the weekend the PBOC also announced financial institutions should re-benchmark loan rates to the loan prime rate (LPR), effectively driving lower lending rates across the economy because the LPR is at 4.15% compared to the old benchmark at 4.35%, notwithstanding cuts to the LPR throughout 2020.
Continued policy support, both fiscal and monetary, will be required to maintain stable economic activity and promote a self-sustaining trajectory for growth. On that basis we expect more RRR cuts and continued support for private firms as this sector continues to drive job creation, accounting for 80% of jobs and more than 90% of new jobs, according to the National Development and Reform Commission of the People's Republic of China.Trade deal, or not, stimulus measures are likely to remain supportive in order to bolster economic growth and are unlikely to be wound back until recovery is more broad based. But by the same token, the degree of stimulus is limited relative to previous rounds due to concerns regarding financial stability. Chinese policymakers are also focusing on quality over quantity in terms of economic growth and grappling with switching from an export-driven economy to a consumption/ domestic demand-led economic growth model. We have confirmation policymakers will aim to do what is necessary to prevent growth collapsing, but slowing trend growth is palatable as China rebalance their domestic economy, whilst avoiding resorting to what officials have dubbed “flood-like” stimulus. Stabilisation is a priority and there is 0 tolerance for a collapse in growth, but targeted stimulus measures and the absence of a huge reflationary package indicate policy makers are tolerant of slower growth rates. There’s a fine line to walk in avoiding accumulating further financial stability risks associated with very high levels of debt and unmanageable credit growth. The problem of clogged credit transmission, however, remains and stimulus measures fall on a weaker economy saturated with debt where the marginal impact of such measures will be less than in previous episodes of stimulus keeping the trend of slower/lower growth in play.