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China: Don’t Listen To The Stimulus Nonsense

China, Company Strategy, Economics

By John Richardson

THE Shanghai Composite Index soared to a seven-year high yesterday on the hope that China’s government is about to launch more economic stimulus because of the release of another disappointing HSBC purchasing managers’ index (PMI).  Factory orders shrank at their fastest rate in just over a year, according to the preliminary May PMI.

The logic here is that once a bit more stimulus has been launched, economic growth will rapidly rebound.

But if you work in the real economy, as of course is the case with the chemicals industry, it is important that you block your ears to this type of unhelpful nonsense. You should instead focus on the critically important issues of the availability and cost of credit in China.

Let me start with providing a bit of history to back up this argument:

  • It became clear from late in 2013 that credit growth would slow down in China during 2014.
  • In February of the following year, the Chinese Academy of Social Sciences, a government-affiliated think tank, warned that if real, as opposed to fictional, GDP growth was going to reach 7.5% for 2014, credit creation would have to expand by 12%.
  • When the final results for 2014 came in, instead of expanding, the availability of new loans had actually contracted over 2013. Go figure what this meant for conditions in the real economy.

Let’s wind the clock forward to today and look at the latest figures for Total Social Financing (TSF). TSF is a measure of the growth of all the new lending in China’s economy, from both official state-owned lenders and the shadow banks.

China-lend-May15

The above chart shows us that:

  • TSF fell by 18% in January-April of this year versus the same period in 2014.
  • Shadow lending was down by no less than 55%, which was mainly the result of the squeeze on the property sector. This tells us that China is playing its “whack-a-mole” games with even greater intensity.
  • Official lending was up just by just 14%.

One of the biggest recent “economic stimulus” measures was China’s decision to cut interest rates on three occasions in just six months.

But despite these reductions, real interest rates have surged to their highest level since the Global Financial Crisis

As the FT writes:

The main impact of the higher real rates is to pile further pressure on industrial enterprises that are suffering declining profits while contending with a welter of debt service charges. In the first quarter of the year, industrial profits fell 2.7% to Rmb1.25 trillion ($200 billion)), after rising 3.3% cent during the whole of 2014 to Rmb6.47 trillion, according to official statistics.

In nominal terms, China’s weighted average lending rate was 6.56% in the first quarter, meaning that companies will have to pay about $812 billion in debt service charges this year on non-financial corporate debt estimated by McKinsey to have totalled $12.5 trillion — or 125% of GDP — at the end of last year.

But if calculated in real terms, the debt service charge on non-financial corporate debt would come to $1.35 trillion this year. To put that number into context, it is not only significantly more than China’s projected total industrial profits this year but also slightly bigger than the size of a large emerging economy such as Mexico.

Many companies are paying out more in debt service charges than they are taking in profits as deflation depresses the prices of the products that they produce. Since September last year, deflation measured by the producer price index has deepened from minus 1.29%  to minus 4.24% in March this year, far outstripping the 90 basis points in interest rate cuts over the same period.

Chinarealinterestrates

This supports my argument that we are heading for a very painful industrial shakeout in the second half of this year and in 2016.

The economy has to get worse before it gets better. The government understands this and is making preparations for the fallout. So when you the read more reports of “new stimulus measures” replace these words with “damage-limitation measures”.