China’s economy looks fine from a cyclical perspective, as data released last Friday suggest. Real GDP growth stabilized at 6% in Q4 2019, ending five consecutive quarters of deceleration, and most monthly indicators beat expectations in December. The continued recovery of automobile, electronic equipment and external demand will offer the tailwind through the next couple of quarters.
China’s financial regulators keep reiterating that raising capital is a top task for banks, especially the medium and small ones. This is necessary partly because Chinese banks need more capital to support its 12-13% loan growth, and partly because the People’s Bank of China (PBOC) wants to avoid more bank failures after bailing out three medium banks in 2019. The large scale of capital raising is positive from a cyclical perspective as it removes a key constraint for banks to lend more, but the downside is that some capital instruments are cross held.
Beijing continues to reform the state-owned enterprises (SOEs) in its own way in order to make them more efficient and powerful. It is expected that a new three-year plan for SOE reform will be released soon, as Vice Premier Liu He chaired an SOE reform meeting in November 2019 and announced to develop an action plan for the next three years.
The PBOC cut reserve requirement ratio (RRR) by 50bps in anticipation of liquidity withdrawal during Chinese New Year. It is rumored that banks are lobbying for another extension of transition period under the new asset management regulations. We think a three-year extension is too much, but a shorter one is likely.
Following the announcement of the Phase One trade deal, two things are confirmed based on the interviews and texts given by Chinese and US officials. First, the tariff escalation has paused for now and the US agreed to cut the September tariff hike of 15% on $120bn Chinese goods by half, to 7.5%.
As Beijing continues to carry on the de-risking campaign, more troubled firms are getting exposed and started to default in the domestic bond market. By the end of last week, the total amount of publicly-traded bond defaults was RMB 63bn in 2019, and it is on track to surpass last year’s RMB 69bn.
The trade war between China and the US has lasted for over 18 months and this has caused damage. China has suffered, but it is not losing very big yet. In fact, its current account surplus rebounds in 2019 and is on track to hit over $200bn (1.5% GDP) for 2019, defying speculations that the country was about to fall into current account deficit.
The Party’s leadership put environmental protection as one of the three key “tough battles” and asked local governments to reduce air-pollution level by 18% in 2020 from that of 2015. So far, most provinces have beat the targets thanks to tough restrictions on the industrial sector, especially in winter when pollution is worse.
We don’t share the view that the market is seeing a rate-cut cycle. The PBOC may be able to cut LPR for another 2-3 times by a total of 10-15 bps, and no more. But even that will only bring the total rate reduction to 26-31bps, which equals to one rate cut under the previous system, still with less impact because they only apply to part of new bank loans. This is hardly a “cycle”.
The room for further monetary easing may be more limited than what the market believes, and it is difficult for interest rates to fall further in China. This is because the economy is likely to set for stabilization or even a mini cyclical rebound after six straight quarters of slowdown, as the outlooks for housing and automobile are quite positive. Also, the economy is not heading for deflation. The decline of PPI year-on-year growth is probably ending while the pork-led CPI inflation is to surge further. Last, the external pressure may also ease slightly if Beijing could strike a truce with Washington.
