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Monday, May 14, 2012

Chinese Economy Still Not Looking Good

Story first appeared in Forbes.

As forecast by nearly everyone in the market, China’s Central Bank lowered the reserve requirements of the nation’s banks, thus freeing up lending as the economic slowdown continues. After a slew of weak trade and economic data out of China, the easing of monetary policy became obvious.

While some investors may see this as a sign of China giving its big four state owned banks a license to over-lend, the real reason is likely to support confidence in the economy and stabilize liquidity, Barclays Capital’s China analysts said on Monday morning.

The iShares FTSE China (FXI) exchange trade fund was down 1.25% in the pre-market minutes on Monday and opened 2.07% lower thanks to a mix of U.S. and European news.  Investors who have an eye on China, of course, are wondering whether the government has a grasp on the economy. Not to mention what the continued blowout in Europe will mean for the country’s weakening exports. This also makes businesses working with Chinese factories nervous about proper China Supplier Quality Management issues with the lagging economy.

The recent cuts to the reserve requirement ratio (RRR) shows that authorities are getting nervous.  Weak credit data in recent months was mainly due to weak demand. The reserve ratio cut is not enough to reverse the trend of economic weakness, because it is designed to ease loan supply not boost loan demand. That’s the bearish view of the RRR news.

The government needs to do more on fiscal side to boost domestic demand. But this is China’s forté. It’s what they do best. The government gets in the way, but the government runs the show, and the government, as economic engine, hasn’t fully disappointed in 30 years.

So on the other hand, Beijing is hitting the economy over the head with a forced slowdown, especially in the high-capital infrastructure and property sectors. The government is  taking measures to stabilize growth by pushing for more investment projects, reducing tax burdens and allowing private sector investment in strategic industries as China tries moving away from being a low-cost manufacturing hub dependent on the ever-declining growth of the developed world.

On balance, the market seems willing to bet, or at least hope, that China’s economy has bottomed or will hit bottom in this quarter.

Now that the RRR is out of the way, what specific policies should investors expect in the days ahead? A Nomura Securities economist has said to expect policy measures similar to those used in 2008 (consumer good subsidies, infrastructure projects) as well as further action on public housing.

There are risks that policy loosening may under-deliver. Note that China’s Central Bank did leave its interest rates unchanged, and only decided to loosen the RRR.  Rates are already low.  If fiscal spending does not speed up quickly, GDP growth faces the risk of falling below 8% in the second quarter.

But let’s face it, China’s not out yet. Not every investor is in this for four months at a pop.  Plus, a 7.5% GDP print in the second quarter is not the end of the world. Nor is it a hard landing.  A hard landing is considered consistent quarterly growth of 7% or less, not just one quarter.

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