As we highlighted (see here), China’s macro data for October 2017 was disappointing with retail sales and industrial production missing consensus estimates, fixed asset investment was in line and inflation surprised on the upside. There was some impact from state-driven efforts to reduce pollution, but this issue will be an ongoing headache for decades. In big picture terms, the challenge for the Chinese leadership is to deflate a credit bubble in an orderly fashion, something which we’re not aware has ever been done on this scale. Notwithstanding the reach of China’s famed central planners, we doubt that they will be successful, a view which seems to be shared by the outgoing PBoC Governor who recently warned of a “Minsky moment”.
In the following charts of GDP, industrial production, retail sales and fixed asset investment, we showed that growth rates in key macro indicators are currently around the lowest they’ve been since the crisis or, in the case of the fixed asset investment, as low as they’ve been for nearly two decades.
Commenting after the October data releases, SocGen is getting equally bearish. To wit.
China’s activity growth decelerated more than expected in October for the most part, while inflation surprised on the upside. Supply constraints imposed by the air pollution reduction programme clearly played a role, while demand slowdown emerged only a little. However, the seeds have been sown for a full-fledged growth slowdown in 2018. Housing tightening has bitten deeper into housing sales; persistent cost-push inflation may dampen the private sector’s appetite for capex; and, most importantly, credit growth – which did not really slow much in October – is poised to trend further lower amid the resumption of financial deleveraging policies.
SocGen notes that while the slowdown in industrial production growth in October 2017 was concentrated in higher value-added sectors, traditional areas of upstream strength are locked in a deeper contraction.
IP growth dropped to 6.2% in October from 6.6% in the previous month. The high value added sectors – automobiles, electrical machinery and computers, telecommunication & other electronics (CTE) – accounted for most of the slowdown in the headline figures, although growth rates in these three sectors were still in the high double-digits. The anti-pollution campaign also left its mark on upstream material sectors, where part of the production was suspended during winter. Production growth of coking coals, cement, steel and aluminium were all in a deeper contraction.
The property sector has obviously been white hot in the latest phase of the Chinese credit bubble, although Xi Jinping’s warning at the recent Party congress that “Housing is for living rather than speculation” is beginning to look prescient. SocGen notes that housing acts as a leading indicator and, while it weakened in October 2017, the decline remains fairly most so far.
Housing sales – one of the best leading indicators – indisputably weakened further. Floor space sold dropped 6% in October, after a 1.1% increase in 3Q. Sales revenue growth turned negative for the first time in 31 months, dropping to -1.7% in October from 3.9% in 3Q. While the sales slowdown at the moment is unequivocally bad news for housing construction in 2018, housing supply indicators did not really deteriorate as much as they appeared to in October. Yoy growth of new starts fell to -4.3% in October from 0.4% in 3Q, but the mom rate was largely in line with the historical average for this month. Similarly, property investments slowed to 5.4% from 7.4% in 3Q, albeit against a negative base effect.
The bull case for China rests on rebalancing the economy from investment-led growth to consumption-led growth. While the slowdown in retail sales is a concern, it’s too early to gauge whether October’s weakness will be sustained in the coming months due to this month’s Singles Day distortion.
Domestic demand softened somewhat. Nominal retail sales growth eased to 10% in October from 10.3%, despite stronger inflation. Adjusted for price effects, retail sales grew 8.6% yoy in October, down from 9.2% in 3Q. Automobile sales – the biggest category – saw its volume growth down to 2% from 5.7%, which seemed to be behind the softer production number in the IP data. However, given the strong increase in online sales at the 11 November sales events (the “Double 11” or the Singles’ Day), part of the weakness in October might be due to delayed shopping.
While SocGen notes the October 2017 credit data undershot estimates, it remains fairly sanguine on the immediate implications.
Although the credit and monetary data came in below market expectations, there was little deceleration in credit stock growth, which means that the much smaller monthly increases in bank loans and total social financing (TSF) were mostly seasonal. While new yuan loans dropped by almost half to CNY663bn in October from CNY1,270bn in September, growth in the bank loan stock softened by only 0.1pp to 13%, which a faster rate than in 1H17. Growth in total credit to non-financial sectors (= TSF - net equity financing + net increases in government bonds) ticked up a little to 14.4% from 14.3% in the previous month.
However, the bank sees three driving a looming deceleration in credit growth.
- Housing-related credit tightening seems to be succeeding. Short-term borrowing by households cooled substantially to CNY79bn in October from over CNY200bn in the previous four months, indicating that regulators’ efforts to weed out the taking out of consumption loans for property purchases has started to work;
- Formal bank lending is likely to be constrained by loan quotas. Reportedly, big banks have either completely or nearly used up their loan quotas for 2017, and there is widely shared expectations among banks that the 2018 quotas1 are unlikely to be much bigger; and
- As financial deleveraging continues, banks’ options to extend shadow lending will be increasingly limited. “Equity and other investments” – the asset item of banks that is most closely related to shadow lending – has dropped by about CNY1trn from its peak in February 2017 (after increasing by CNY19trn since 2014).
Most importantly, financial deleveraging is poised to pick up soon. In addition to talks by senior policymakers of more regulation, the Financial Stability and Development Committee, the high profile body in charge of this project and headed by a vice premier, has concluded its first gathering and reconfirmed the policy direction only two weeks after the Party Congress. The expectation of tighter regulations has already driven up bond yields onshore.
After the Chinese leadership permitted the credit engine to be revved up again from early 2016 through to the early part of 2017, most commentators have put fears about China to the back of their minds, preferring to focus on the synchronised global growth narrative. The reality is that massive credit bubbles are not only dangerous, but we suspect, inherently fragile, when central planners try to fine tune them.