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ECONOMY: Monthly Economy Report
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Monthly Economy Report

By Andrew Smith

BT 201506 44 EconomyLast month we reported on the signs of weakness that were coming to the surface in dramatic fashion during the first quarter. We predicted that the slowdown would continue and that there is a good chance of an interest rate (i.e. a reserve requirement ratio) cut by the People's Bank of China. From the latest data it seems that unfortunately our estimations were correct.

Surprisingly both imports and exports have fallen even further than they did last month. According to official figures, exports fell by around 6.4 percent in April from a year earlier. It is no secret that external demand is poor. Going forward the outlook may be even gloomier if the recent data coming out of the United States is an accurate indication of a slowdown in the world's largest economy. China's net imports also continued on a downward trend in April, with a 16.2 percent fall; making it an even more drastic dive than the shocking 127 percent fall in March.

These figures came as a surprise to the analysts, who had broadly been predicting a 2 percent rise in exports and a 12 percent drop in imports during this period. They were also taken aback by the fact that the traditional Spring Festival slowdown had not yet ceased. "This [Lunar New Year] effect should have fully dissipated last month, so it is slightly surprising that export growth remained in negative territory," said Julian Evans-Pritchard, China economist with Capital Economics. He also noted, "The trade data suggests that both foreign and domestic demand has softened going into the second quarter".

BT 201506 42 Economy HLGoing forward financial commentators are divided on whether or not China trade data will improve over the course of the year. Analysts Liu Li Gang and Zhou Hao of ANZ Research have argued that, "As the port throughput data remain soft, we continue to see strong headwinds in China's trade sector in the foreseeable future. We expect that authorities will reduce tax burdens by rolling out more export tax rebates and will cut interest rates further to lower firms' funding costs. In addition, it is likely that China needs to add targeted stimulus on both fiscal and industrial sectors". However, not everyone is so pessimistic. Julian Evans-Pritchard of Capital Economics thinks that, "Economic growth in developed markets will likely hold up relatively well this year and most other indicators, including the export orders component of both manufacturing PMIs, don't suggest that foreign demand is falling off a cliff. As a result, we expect negative export growth to prove short lived".

Stimulus measures have been on the cards for some time now and it didn't take anyone by surprise when the central bank enacted a further rate cut, which took effect as of Monday 11 May. The much anticipated move lowered the benchmark rate by 25 points to 5.1 percent. This is the third rate cut in six months and it follows on from a series of sizable stimulus measures, both in terms of monetary policy and fiscal policies (particularly tax cuts), that are aimed at keeping growth momentum in the economy. If the overall slowdown continues then it is almost inevitable that we will see more action on the monetary side later in the year. According to Li Huiyong, an economist at Shenwan Hongyuan Securities, "This won't be the last cut. The rate could be lowered to 2 percent at least, and we expect the economy to gradually stabilise in the coming two quarters".

We may also see some spending from the central government, which is still very much supportive of big infrastructure projects in China and the surrounding region. However, as New York Times columnist David Barboza has pointed out, "Chinese policy makers now face an unappetizing choice. They can continue to cut interest rates and bank reserve requirements in a bid to stimulate bank lending and keep the economy growing fairly strongly. But that extra lending would only expand further a debt load, particularly at local governments and state-owned enterprises, which has been surging as a share of economic output ever since the global financial crisis in 2008 and 2009".

BT 201506 43 EconomyParadoxically, amongst all the talk of economic slowdowns and asset bubbles, Chinese stocks have rallied at an incredible pace over the last 12 months or so. In fact the markets were up by more than 100 percent at the start of May from the previous year after what had been a raging bull market of epic proportion. However, with the economy slowing down and real estate prices slumping, analysts are warning that the Chinese equity markets may well be the next big bubble waiting to burst in the world's second largest economy. In a recently published report, the Reserve Bank of Australia (RBA) said that, "Equity prices in mainland China have more than doubled since mid-2014, with both the Shanghai and Shenzhen exchanges rallying sharply over this time. This rally has been broad based across sectors, and has occurred despite slowing economic growth. It has, however, coincided with rapid growth of debt-financed retail investment in the stock market".

Could it be that we are now in for a Middle Kingdom meltdown that makes the U.S. stock market collapse in 2008 look tame? Only time will tell but the key indications are certainly not encouraging. In early May stocks suffered from a big sell-off by major financial institutions. Hao Hong, a strategist at Bocom International Holdings Co. in Hong Kong, says, "Large Chinese institutions are probably choosing that time to place sell orders as they gradually re-balance portfolios to accommodate a 109 percent surge in Shanghai shares over the past year". Whether he is right or wrong we will need to keep a close eye on developments in Chinese assets as they move closer in line with what is happening in the wider economy.



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