This is what two HSBC economists named Julia Wang and Jing Li in Hong Kong wrote last Monday after China announced its lowest GDP growth record, 6.9%, in six years:
Overall, today’s data point to some signs of stabilisation in the Chinese economy. But challenges remain. We forecast another 25 basis points (0.25 percentage points) policy rate cut and 150 basis points (1.5 percentage points) reserve ratio cut in the remainder of 2015.
Four days later, on Friday, the People’s Bank of China did just that, announcing a 25 basis point cut in the benchmark lending rate to bring it down to 4.35%, while reserve-requirement ratios for lenders were reduced by 50 basis points.
The HSBC economists were prescient. But, then again, so was everyone else.
Economists that Bloomberg surveys predicted back in September that China’s central bank would relax reserve requirements for banks again before the end of 2015 and cut lending rates. The median estimates: the central bank would lower the benchmark lending rate by 0.25% in 2015 and reserve requirements by a full percentage point by the end of 2016.
So Friday’s news could have been the least surprising in the last year of China’s efforts to speed up the slowing locomotive that is its economy.
If almost everyone following China expected more interest rate cuts in 2015, yet stock market investors were surprised by the cuts and sent stocks rising (pundits said U.S. stocks rose 1% on the news) , there’s either a disconnect between what’s happening across China and what some observers think is happening, or, more likely, stock markets, which are complex systems, rose on Friday because of reasons beyond China. (The fact that it came only one day after the European Central Bank virtually promising to give markets another sugar rush in December probably didn’t harm, either.)
For now, what is happening in China? The clearest explanation may be that China’s old growth model—fixed investment— has hit its limit, and its next growth model—consumption–isn’t strong enough to replace it completely. So the government appears to be managing a slowdown so the economy doesn’t come to a standstill, unleashing a series of monetary fixes like interest rate cuts, and fiscal fixes, like infrastructure spending. Lower interest rates allow homebuyers to save some on their mortgages, and also, at the margings, reduce the cost of finance for companies, although it’s hard to see many Chinese companies getting too excited about a 0.25 percent cut when producer prices are falling at an annual rate of nearly 6%, implying a real (i.e. inflation-adjusted) interest rate of over 10%. This is savage debt deflation, and Chinese companies are deeply indebted—corporate debt is more than 150% of GDP, among the highest in the world.
This is why keeping companies from defaulting won’t help China with its bigger, structural transition. “Cuts in rates mean practically nothing for China’s long-term economic prospects,” writes Gavekal Capital’s Bryce Coward. “…These are cyclical boosts that act as tailwinds to China’s economic train. No amount of wind, save a hurricane, is going to keep the train from slowing.”
The government is likely fine with a slowdown. But not when those previously mentioned indebted companies might turn a slowdown into something far more serious.
Sources leaking info from China’s central bank indicate that the government is freaked out now that the slowing economy is imperiling companies. The Wall Street Journal notes that until this summer, it was unusual for China’s central bankers to employ the twin salvo of interest rate cuts and bank reserve ratio requirement cuts, which the bank did on Friday. “A lot of companies have seen their profitability falling sharply and that’s a key reason why we took the action again today,” a ‘senior official’ at the PBOC told the newspaper.
“Slower growth is part of China’s rebalancing process,” Moody’s credit rating services concluded today.
But that rebalancing may be anything but smooth for China and world markets, as evidenced Friday, even if economists get all their predictions right.