My Blog

October 30, 2008

China’s stock markets keep bouncing around, sometimes in synch with the rest of the world and sometimes out of synch.  Yesterday it was out of synch as it lost 2.9%, largely because a number of corporations announced lower-than-expected earnings growth.  A useful chart I filched from yesterday’s Wall Street Journal Asia shows the slow-down:

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Today Chinese stock markets seemed to rejoin the global pack with the SSE Composite rising 2.6% to close at 1765.  Last night’s interest rate cuts by both the Fed and the PBoC spurred some limited optimism and especially drove up financial stocks.  The 3-year deposit rate was cut by 36 bps (greater than the traditional 27 bps), the 5-year deposit rate was cut by 45 bps (ditto) and the 1-year to 5-year lending rates were cut by 27 bps.

I say optimism is limited because trading today was sluggish and volume very low.  We have now closed four days in a row below the supposedly solid support level of 1800, below which (once again) the market could not go.  In belated recognition that 1800 was not as rock-solid as they had once thought, the government seems to be backing away from the introduction of short selling and margin trading – a policy it announced a few weeks ago to my great surprise.  According to an article in yesterday’s South China Morning Post:

The central government is set to delay the launch of margin lending and short selling amid mounting worries the potentially risky trading methods will exacerbate market turbulence.  Sources said the State Council had put on hold plans for the much-anticipated launch next month because of fears the introduction of the practices could send the market into another tailspin.

It is another remarkable about-face for mainland financial regulators, who delayed the introduction of index futures last year after getting cold feet about the impact on the market.

It may be embarrassing for them to have retreated so dramatically, but it is better to be embarrassed than wrong.  Hopefully their retreat won’t have added to market fears.

What is more likely to inspire fear is information recorded in an interesting article by Geoff Dyer in today’s Financial Times.  One of the things that had surprised me recently was the continued strong domestic demand in September.  I had expected that as the buying spree associated with the Olympics wore off, we would see a sharp drop in the growth rate of domestic consumption.  So far that hasn’t seemed to happen except in certain big-ticket items, like cars and apartments.

In fact in September retail sales – the best available but not always satisfactory proxy for household consumption – grew at a record pace in nominal terms, around 23% year on year, and with the decline in CPI inflation this translates into even higher relative real terms.  But the things that we can measure didn’t hold up as well as that might imply.  

Car sales, for example, in September were down around 4% (I am quoting from memory, so the number may be wrong), which is the first time this has happened in many years, and I am hearing that October isn’t going to be much better.  Fewer people flew on domestic airlines last month than they did in September of last year.  And not only are real estate prices dropping quite quickly, but volume seems to have collapsed.

Yet the September numbers show healthy retail sales growth.  Perhaps weakening demand will show up in October numbers.  According to Dyer’s article:

Signs are growing that China’s economy could be cooling quicker than expected, with a string of big industrial companies announcing production cuts over the past week.  The cuts have come as anecdotal evidence from other companies suggests a surprising weakening of demand in October amid the global financial crisis and a local housing market slowdown.

…”Orders for cars and home appliances have already begun to shrink,” Xu Lejiang, chairman of Baosteel, China’s biggest steelmaker, said last week.  Zhou Xizeng, analyst with Citic Securities, said steelmakers were trying to adjust rapidly to uncertainty about demand and an inventory build-up. “The recent drop in production is a sort of psychological panic,” he said.

Executives in a number of other industries also said demand had been unusually weak in recent weeks.  But some executives said the slowdown could also reflect shorter-term factors such as customers reducing their inventories because of global uncertainties.  “We had been expecting this to pick up a bit after the end of Olympics restrictions on factories, but things have been very quiet,” said the chief executive of the China operations of a large paints company. “We are trying to work out how much is due to weak demand and how much to destocking.”

As I have said many times on this blog, rising inventory is going to be a key indicator of trouble ahead.  So far we can find trouble in specific areas, but inventory levels on the whole seem fairly stable.  Obviously this will change if we see a real slowdown in demand, but so far the numbers are not disquieting.  

On that note a group of about a dozen crack Peking University finance students, mostly graduate students, have recently formed the Guanghua Students Monetary Committee to act as a sort of shadow PBoC, and Logan Wright and I are their advisors.  They will meet every Saturday to analyze economic and financial market conditions and the PBoC balance sheet, and to discuss PBoC policy, and one of the things they plan to compile and report on is inventory levels among Chinese corporations.  They’ll have their own website up and running soon enough, and I’ll publish the address when that happens, but I expect to be able to use some of their findings in this site.

Finally, before closing I want to flag, for those who are interested, another excellent report from Standard Chartered’s Stephen Green.  This one, called “China – How much bang for the fiscal buck” was published on October 27 and starts out:

How much growth can we expect the Ministry of Finance (MoF) to provide over the next few years?  With China’s economy slowing, many folk are already breathlessly awaiting a fiscal   rescue.  In recent notes we have looked at how other governments stimulate their economies, how China organised its stimulus package 10 years ago, and how this coming package might be funded. Today, we think through what such stimulus might mean for GDP growth and the overall economy.

Green attempts to estimate the parameters of fiscal expansion and the amount by which it might boost next year’s GDP growth, and his calculations will surprise many.  He figures that an expanded fiscal package might only add 0.5-1.0% more growth in 2009 than it did in 2008.  Fiscal expenditures, in other words, are unlikely to make up for any significant slowdown in the economy due to slowing exports, weakening domestic demand, or declining investment unless the expansion is much greater than most think it is likely to be.

I have no ability to forecast or estimate growth based on anything more sophisticated than my previous experiences working in countries that have gone through economic slowdowns with weak balance sheets, and the two tend to be self-reinforcing, so the smartest projections tend systematically to under-estimate growth in rising markets and over-estimate growth in declining.  As I have said often enough, I expect to see analysts continuously revise their estimates downwards for the next few quarters, as they have already been doing.  Already I am hearing a number of pessimists posit 7% as an upper limit.  Yikes!

Comments (13) for "Rising domestic demand? Decl...

In addition to fiscal policies, it looks like the PBoC has embarked on a rate cut cycle now that inflation threat is subsiding. Wouldn't additional rate cuts spur consumption and investments, if the PBoC also relax loan quotas? By Sergei - 10/29/2008 7:34 PM

I agree money growth has been strong in the past few years, which might make the financial system unstable, and cranking up money growth might add further instability. However, given the strong GDP growth in the past few years and rising household income, has household leverage and corporate leverage increased significantly? I remember reading anecdotally a large portion of corporate investment are financed by retained earnings? By Sergei - 10/29/2008 7:46 PM

Most "official" and aggregated statistics I see from China seem to conflict with the reported statistics from individual companies and collections of individual companies. So toll road volumes are falling, while the government aggregate highway volumes are growing as usual. Export statistics continue growing, while most ports report sharply fading volumes. Airline volumes are shrinking. Property sales are falling. Steel production and prices are plunging. I wonder what is the "dark matter" that is filling the gap between observed data and official statistics? I'd like to hear about how exactly Chinese economic statistics are being calculated. I wonder how much of the data is being filled in by presumed correlations or seasonal adjustments By A.West - 10/29/2008 8:18 PM

Anywhere I can find the Standard Chartered’s Stephen Green's report? I think everywhere the recession is a self-reinforce process. The economy will go down until that the bad debts or loss have been absorbed. In China's case, productivity needs to be grow to a new high to bring up the demand. I am interested to see your students' work on inventory, what are their data sources? By fatbrick - 10/30/2008 12:01 AM

A.West, Official data is lagged, always. By fatbrick - 10/30/2008 12:03 AM

How much longer till China buckles to the IMF? They must really want some serious trade concessions at the G20... http://www.businessweek.com/ap/financialnews/D944RDTO2.htm By Phil - 10/30/2008 12:35 AM

A.West: I wonder what is the "dark matter" that is filling the gap between observed data and official statistics? Part of it is lag and time smoothing. It takes time to aggregate the statistics. A lot of times what happens is that statistics on individual companies just give you a snapshot view that misses something that is in the aggregate statistics. Also you run into skew issues. For example with SOE's until recently you have a small number of large companies and a large number of small companies, so how you put together the statistics can give you very different numbers. To figure out what is really going on, you need to not look at one or two numbers, but rather look at 50 or 100 to try to figure out what is going on. A. West: I'd like to hear about how exactly Chinese economic statistics are being calculated. I wonder how much of the data is being filled in by presumed correlations or seasonal adjustments For any statistic there are probably dozens of pages that have been written on where the number comes from, and what they mean. The story is different for each statistic. By Twofish - 10/30/2008 1:18 AM

AWest, Twofish and fatbrick are right about the complexity of compiling statistics even with the best will in the world, but there is something unsettling about the numbers given the difference between aggregates and anecdotal evidence. Sergei, the problem right now seems to be not that banks can't lend because of loan growth constraints but rather that they don't want to lend. In the formal banking sector I assume that the government can always force the banks to expand their loans (although that creates a whole secondary set of problems), but I don't think they can force the informal banks to lend, and if lenders really want to cut back, I think real credit in the system will contract. Unfortunately we won't have the numbers to show this until it already happens and we see the consequences. By Michael Pettis - 10/30/2008 11:41 AM

Fatbrick, you should call or write to the research group at Standard Chartered and see if they will send you a copy of the report. I am on their mailing list and I think they do some of the most interesting work on China of any of the banks. By Michael Pettis - 10/30/2008 11:54 AM

Michael: "countries that have gone through economic slowdowns with weak balance sheets, and the two tend to be self-reinforcing, so the smartest projections tend systematically to under-estimate growth in rising markets and over-estimate growth in declining." Could you please explain a bit more on this? 1. What does <the self-reinforcing relationship between economic slowdowns and weak balance sheet> have to do with the wrong growth projections? 2. Why do you say the smartest projections "systematically" get the growth estimate wrong? Thank you. By RBG - 10/30/2008 3:17 PM

RBG, the short answer is that the structure of the balance sheet can either dissipate volatility (i.e. implicitly hedges the operating side of the economy) or exacerbate it (i.e. is "inverted"). Usually periods of excessive money growth result in balance sheets that systematically exacerbate volatility since, in rising markets flush with liquidity, volatility enhancement turns out to have been the "best" strategy. In fact I would argue that by definition financial crises only occur when the latter has occurred. These kinds of balance sheets create the boom and bust conditions typical of many emerging market countries. To take a simple and obvious example, when Korean companies borrowed dollars to fund their local operations before the 1997 crisis, periods of growth in Korea were matched by declining debt servicing costs (as the won strengthened in real forward terms) so that corporate balance sheets improved even more than they otherwise would have and financial distress costs were sharply reduced. This has the effect of encouraging investment and enhancing the already good economic conditions. But when conditions turned, as they did in late 1997, the contracting economy was matched by ballooning debt (as the decline in the won caused dollar leverage automatically to rise), thereby forcing liquidations and financial distress costs onto the corporates. This then caused corporates to cut back on investment and reduce expenditures, thereby making the economic contraction worse than it would otherwise have been. Another obvious example was the short term financing of Brazil’s very high fiscal deficit in 1997 and 1998. When conditions were good and confidence rising, declining interest rates caused the deficit to drop sharply, thereby enhancing confidence further and encouraging investment. However in 1998 the Russian crisis caused capital flight and rising domestic interest rates, which caused the deficit to rise so sharply that it created further drops in confidence and further interest rate increases, which of course caused an unexpected collapse in investment, and so on in a brutal circle. Most of my book, The Volatility Machine, is about the history and corporate finance of just this kind of unstable balance sheet. By Michael Pettis - 10/30/2008 6:10 PM

Really appreciate all the comments in addtion to the original post. By Socical Media Marketing San Jose - 3/23/2009 2:47 AM

There is only one good thing to say about the Chicom Kommie Bastrds. Which is: Let them eat Sht and die. On this propitious day, leading up to June 4, the commemoration of the day when so many of our comrades were cut down in hails of lead bullets, then there is nothing more to say. Other than to say, whenever one prays at night, to give a fcking payer that these fcking Kommie bastrds will soon be cut down to size, cast off, and banished to hell, which is what they have deserved, for so many fcking years. How much longer do we need to wait before justice is done????? These Kommie basrrds just keep hanging on. While they stifle the good life of over a billion people. So, when you go to sleep at night, just while you are kneeling praying to God, then you just might add a little prayer, that these FCKING Kommies WILL FINALLY BE FORCED TO EAT DOG SHT before descending into hell to meet their eternal damnation. Yes. This means you, HuJinTao, you despoiler of life. You fcking low life Kommie Bandit. Suck your dick and die. Get off your tiny pedestal and hold some fcking democratic elections. You pc of sht. Or is it that you care too much about your own wellbeing than you care about China? By FCK_HUJINTAO - 5/28/2009 5:04 AM