International | Aug 22 2012
By Greg Peel
Chinese data, as it is well known, is dodgy. Even Beijing admits its published GDP results are more of an estimate than a reality, arriving three months ahead of any equivalent calculation from developed world economies. China's most recent June quarter GDP result of 7.6% growth had many economists scoffing given such a figure seemed well out of whack with supposedly more reliable, and weaker, electricity production data. The Macquarie economists put it politely by suggesting recent data offers “limited clarity”.
So the economists decided the best idea was to check it out for themselves, and to talk to the Chinaman on the ground. Off they thus flew to Fujian province to talk to seven different manufacturers boasting both domestic and export sales across a wide spectrum of products.
Weak demand is the biggest concern for the man on the ground, Macquarie found. The recent deterioration is worse than that experienced in 2008-09. This has led to inventory drawdowns and destocking and that means restocking is not far off, as the world is hoping, but Macquarie believes restocking is “unlikely to be very strong”. Some companies are selling manufactured goods at a loss to keep counterparties at bay and if things don't improve soon, SME bankruptcies will surely grow, the economists suggest.
While the Chinese labour market is structurally stronger today than it was in the GFC, weaker demand means workers are easier to find and the lagging economic indicator of unemployment is creeping in. With so much competition at home, many Chinese companies are finding better margins from setting up operations in foreign markets. We may see a future rise in exports of capital goods from China, Macquarie suggests.
Overall, the picture appears rather gloomy. However Macquarie is prepared to believe a healthy process of sifting out the less competitive players is underway, leaving financial, material and labour resources more readily available for the survivors. In other words, says Macquarie, “the seeds of recovery are being planted” and we are simply in the middle of that process.
Interestingly, some in China actually blame Beijing's enormous post-GFC stimulus package as the source of current problems. Everyone in China thought they must be smart and successful following strong stimulus-driven performance, but in fact the prosperity was fake, they've come to appreciate. Reality has now set in. The question is, Macquarie asks: If Beijing were to introduce a second package, would this time be different?
For BA-Merrill Lynch's equity strategists, China's manufacturing sector does not provide the area of greatest concern for the overall Chinese economy. The manufacturing sector has indeed come under tremendous margin pressure in recent years due to rapidly rising labour costs, overcapacity in industry and a strong currency, however it is Beijing's on again-off again approach to property sector policy which is providing the real economic risk.
Beijing wants to get it just right. The government initially provided stimulus but then had to tighten policy as a property bubble began to inflate. Beijing has nevertheless been quick to ease once more on subsequently weaker GDP growth, suggesting to prospective property investors, Merrills believes, there is a “property put” in place. Buying property is safe because Beijing will not let the market actually collapse. Beijing is thus on the horns of a dilemma.
While fixed asset investment growth for property continued to decelerate in July, both volumes and prices were up sharply, with the “property put” providing impetus. This is not what Beijing wants to see. If monetary policy is once again tightened to avoid a price bubble (and by default subsequent bust), the Chinese economy will likely come in for a feared hard landing, resulting in a major stock market sell-off, Merrills warns. On the other hand, easier policy will only fuel the bubble. High real interest rates are a problem for the manufacturing sector and hence Beijing really needs to ease, but all the liquidity will flow into property, Merrills believes, and not into manufacturing as intended.
We are approaching the September/October peak season for Chinese property sales. Beijing's likely course of action is to cut interest rates while simultaneously applying fiscal property dampeners such as tax increases, Merrills suggests. What one must realise is that property investment represents 12% of the Chinese GDP and, after applying the multiplier effect, potentially over a quarter of aggregate demand, Merrills points out. A new round of property policy tightening will damage growth.
Moreover, a property sell-off would hit the financial markets through loan defaults, leading to forced liquidation of collateral, leading to further property sales, and the negative feedback loop would continue. The next two weeks represent a Chinese property policy danger zone, Merrills warns.
“We reiterate our view,” says Merrills, “that we are fast approaching the day of reckoning and investors should stay defensive”.
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