China has no choice but to stimulate

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Will China be forced to stimulate?

The near-universal reaction in the West to China's 5 percent GDP growth target: Good luck with that.

Growth in 2023 – if you believe the data – was 5.2 per cent, with more than two-thirds of that coming from a modest rebound of consumers from scratch. Now these tailwinds are over, consumer confidence remains very poor. New problems began to emerge: local government debt reduction, excess industrial capacity, and capital outflows. Current fiscal and monetary stimulus efforts have been tepid. “There is little evidence that Beijing has the policies in place to achieve its stated growth target,” the Financial Times editorial board summarized.

The old engines of growth – real estate, infrastructure, and manufacturing – face major constraints. The structural decline of the property is well known. Home prices and sales continue to decline. At the same time, infrastructure has reached the limits of high debt levels. Chinese officials were sent last year to urge local governments to fulfill their commitments. It started with easy cost cuts: withholding wages to civil servants, delaying payments to vendors, and cutting city services. But more recently, the deleveraging drive has hit infrastructure projects already underway, as Reuters reported in January:

As part of its efforts to manage $13 trillion in municipal debt, the State Council in recent weeks directed local governments and state banks to delay or halt construction on projects in which less than half of the planned investment has been completed in 12 regions across the country, the sources said. He said.

Also, over the FT weekend:

In southwestern Yunnan, 1,153 government-funded infrastructure projects such as highways and theme parks have been put on hold and new construction halted to limit expenses and focus on settling debts, according to a document seen by the Financial Times.

It is difficult to see how this will not hinder growth in the near term.

Finally, manufacturing. Since about 2020, credit that was flowing to the real estate sector has been redirected to manufacturing, especially in politically favored sectors such as solar and electric cars. The year-on-year growth rate of loans to Chinese industry has risen steadily, although the level is now declining (see chart from Clocktower Group below). In contrast, credit growth is slowing in general, and is contracting completely in the real estate sector:

This pivot back to manufacturing is “radical,” says Adam Wolf of Absolute Strategy Research, and has delivered important victories for China. It is worth noting that BYD is now the largest electric car maker in the world, and China is the largest exporter of cars. But it has also created a massive oversupply of manufactured goods, which, when combined with weak demand at home, crushes industrial margins and fuels deflation (Wolf chart):

China can deal with this problem, as it has done in the past, through a combination of state-directed industrial consolidation and increased exports. But China's industrial trade surplus is already huge, perhaps reaching 2 percent of global GDP. As Gavical's Yanmei Xie wrote in the Financial Times last month, Western countries reasonably fear China will flood export markets with cheap goods. A cheap renminbi increases the threat; Trade retaliation is widely expected. If this is true, then export-led growth may not be an escape valve for China.

This bleak picture suggests that China may soon have to stimulate. Assuming the GDP target is at least somewhat binding, no sector of the Chinese economy will be willing to raise the growth rate to 5 percent. Rising consumption might make this happen, but we haven't heard any compelling story as to why anxious consumers would suddenly fall into the grip of animal spirits. As Michael Pettis, the noted China watcher, wrote on Friday:

Although Beijing has been very reluctant to do so so far, there appears to be a growing consensus among Chinese economists and economic policy advisers that Beijing should direct fiscal expansion not toward boosting the supply side of the economy, but rather to finance a one-time increase. in household income – perhaps through consumption vouchers – to encourage Chinese families to expand their consumption…

If not [a rise in net exports or sudden rise in consumption] It is happening [over the next quarter]I would be surprised if Beijing does not resort to more direct consumption subsidies. In this case, we can expect that sometime in the third quarter, or perhaps by the end of the second quarter, Beijing will seriously consider the possibility of making a financial boost—perhaps as much as 2 to 3 trillion yuan—directed toward achieving the Sustainable Development Goals. Income for the household sector

Even if Beijing chooses to accept below-target growth, ASR's Wolff argues that China faces a more fundamental constraint: the labor market. Aside from the chronic issue of high youth unemployment, the official unemployment rate has been stable, and alternative private sector data looks calm enough. But Wolf believes this may soon change:

So who [Chinese authorities’] In my view, these are just transitional pains to a new growth model. They do not want to provide more stimulus, because they do not want the economy to return to the old growth model. They want to see the real estate sector shrink as a proportion of GDP. As long as people have jobs, [officials can tell themselves that] Things are fine; Just stop complaining!

But you can see the contraction in the real estate sector continuing this year. Completions are now taking place long before housing starts, so the actual building work will finish soon. If the government also starts attracting infrastructure spending, the construction sector will start shedding workers at a much faster pace.

He says the deteriorating labor market will be a “real impediment to the government's ability to move forward”, potentially forcing it to expand its stimulus plans.

Where does this leave China-curious global investors? We have argued that choosing a turning point in Chinese markets will be very difficult and will come down to advocating ambiguous Chinese policy. Recent developments illustrate this point. Unclear stimulus expectations have left the bulk of investors nervous, but stock outflows have at least halted. The stock market has risen 14 percent since early February, but only because of significant support from the state. Value trade or value trap?

What makes us skeptical is the fact that Chinese stocks are not much cheaper than global stocks. After the rally, the CSI 300 trades at 13 times forward earnings, versus 14 times the MSCI World Index ex-US. For us, the risk in Chinese stocks is more clear than the reward. (Ethan Wu)

One good read

Amazon's foray into nuclear power, from FT's Lee Harris.

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