China: When Sentiment Tells Us Something Important

By John Richardson

ChinadebtWallStreetJournalTHE blog once asked a seasoned petrochemicals industry consultant what the price of polypropylene (PP) was.

“It depends on whether the Hong Kong traders are in a good or a bad mood this morning,” was his reply.

Excellent point, of course, because sentiment plays an important part in market direction – and, quite often, sentiment seems to have nothing to do with the economic reality out there, but has instead more to do with irrationality. If the weather  lousy and there is a widespread outbreak of the common cold, for example, the majority of traders might wake up one day and decide to go short.

But in some cases, as is the case today, sentiment tells us something much more significant – as the China Beige Book (CBB) Q2 survey, which we referred to briefly earlier this week, indicates.

What the survey points to us a significant increase in caution by businesses across many sectors because of a recognition that the tough reform programme is going to continue.

In detail, the survey tells us that:

  • Only half of CBB respondents said they were increasing investment, down from 58% in Q1 2014—the sharpest drop in 10 quarters of polling.
  • During the quarter, non-bank borrowing costs—including shadow banking rates—fell to an average of 6.3%, down from more than 8% in Q1, while bond yields averaged 5.8%, a one-percentage-point decline. Both types of credit are now cheaper than official banking rates of around 6.9%. CBB has tracked this sort of “loan inversion,” which usually happens during times of financial stress, in specific regions before. But this is the first time the trend was evident throughout the country.
  • In other words, what’s hurting growth isn’t a tighter supply of loans resulting from government policy, but rather eroding demand for credit. Only 26% of companies said they tried to get loans, down from 32% in Q1 2014. Almost none of the bankers CBB interviewed reported that their business was coming from new clients.

The latest CBB survey, and the dominant mood amongst petrochemicals  traders and buyers, tells us that businesses recognise that the much-discussed latest “mini-stimulus package” doesn’t represent a change in the government’s overall direction.

Sure, more “whack a mole” problems might also give speculators some temporary room to make a bit more money, or  minimise their losses in real estate etc.

But the mood music isn’t going to change, given the constant stream of data that indicates just how deep a hole China is  in – and therefore, how pressing the need is for further reforms.

For instance:

  • Since the government started pulling back on formal bank lending at the end of 2009, China’s shadow banking sector has grown exponentially. It has provided more than RMB 30 trillion ($4.8 trillion) of loans since 2007. Together with the banking system, loans have expanded by 87% of GDP since 2006.
  • More than 10,000 “local government financing vehicles” have been set up to circumvent local government borrowing limits. By the end of 2013, they held more than 31% of GDP in off-budget financing for local governments.
  • Total debt in the Chinese economy has risen from 130% of GDP in 2008 to 220% of GDP in 2013, with assets in the formal and informal banking sector increasing from $10 trillion to $25 trillion.

This change in sentiment is driven by much more than just a period of lousy weather and a bad dose of the common cold.

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