Friday, April 4, 2014

Mini-stimulus in China

This post started off yesterday as a discussion of the policy options open to the Chinese authorities should  they feel the need to do something to stimulate the economy and at what point they might do that.   After yesterday's announcement we know the answers to those questions are that fiscal stimulus is the first cab off the rank and they are worried about it now.

At issue is the weaker than expected activity data at the start of 2014 with industrial production, exports and retail sales all coming in below the bottom end of consensus expectations.  Our forecast growth track for this year assumed a soft start to the year on the back of domestic weakness, stabilisation in the middle of the year and some upside in the second half of the year on the back of renewed impetus to exports as global growth improves.

Data for the first two months of the year shifted the forecast risk to our March 2014 GDP forecast of 7.4% to the downside and forward looking data such as the PMI, while supporting our thesis of a soft domestic start to the year bolstered by exports later on, suggests growth would most likely deteriorate further in the year to June, to perhaps as low as 7.0%.

That’s all in the context of a 7.5% growth target and a strong commitment to structural reform.  There has been a high degree of equivocation over this year’s growth target with various members of the leadership talking at various times about the target not being a hard target and commenting that growth of 7.2% or 7.3% is “close to” 7.5%.

The prospect of a number closer to 7.0% in Q2 has been sufficient for them to act.  Remember the Chinese authorities have been able to continue to focus on structural reform because the labour market has been holding up well.  But there was always going to come a point at which they would become concerned about low growth and its implications for the labour market and opt for some cyclical support for the economy.

The good news is that with inflation running at 2.0% and a forecast budget deficit for 2014 of 2.1% of GDP, there is ample room to move on both monetary and fiscal policy.  The inflation target for 2014 is 3.5%.

As we suspected the initial step has been fiscal.  Yesterday’s stimulus package focussed on infrastructure (railway) and housing spending.  It also offered tax breaks to small business.    There is plenty more ammunition should it be required.  There is more room for fiscal stimulus, which we expect will remain targeted at infrastructure spending (more rail, social housing, energy saving initiatives, environmental protection).  On the monetary side of the equation PBoC has tool at its disposal to provide liquidity to keep the cost of capital down such as suspending repos and cutting the reserve ratio.

While the size of the package was relatively small by China standards the more important point, at least for financial markets, is that it has removed the uncertainty about at what point the authorities would step in and support growth.