Policymakers may have hit the brakes too hard
The most recent macro data
releases from China give rise to the strong conclusion that Chinese
policymakers have unwittingly hit the monetary brakes too hard and thus the
balance of risk has finally tipped slightly in the direction of a hard landing
in 2012.
The odds appear slightly better
than 1 in 2 – the definition of a hard landing for China being growth below 5
percent for two quarters. When a hard landing scenario finally plays out, the
possibility is growing of an even bleaker outlook: 3 to 5 percent growth for a
year or longer.
Time is of the Essence
The risk of a hard landing will
continue rising over the coming weeks unless and until policymakers reverse
course and implement aggressive and timely policy easing. Despite ominous signs
of a sharp slowdown in growth evident in macro data releases and other select
bank and financial sector data in the recent past, policymakers can probably
kick the hard landing can down the road by six months to a year or so with an
aggressive policy reflation operation. The question is whether they will.
These ominous signs include
worse-than-expected Purchasing Managers’ Index results, a year-on-year decline
in foreign direct investment in November, the first since 2009, a
sharper-than-expected decline in the consumer price index in November, weak
external demand reflected in slowing exports, a lower than expected growth rate
of M2 in November, deposit and capital flight, and continued currency weakness.
Ability (Yes) vs. Willingness (???)
Chinese policymakers still
retain what seems to be ample dry powder with respect to three main policy
levers: monetary, fiscal and administrative, suggesting that they could
hypothetically reflate economy (albeit temporarily) if they pulled out all of
their policy stops right now.
Dry powder on the monetary side
includes roughly 16 trillion yuan worth of bank reserves currently locked up on
bank balance sheets resulting from a historically high reserve requirement
ratio of 21 percent. Dry powder on the fiscal side includes a large fiscal
surplus through the first 11 months of the year, equaling roughly 2 to 3
percent of gross domestic product. Dry powder on the administrative side
includes restrictions on real estate that could be unwound quickly in order to
reverse the nascent (but alarmingly sharp) decline in real estate transactions
and primary market prices.
Policymakers did announce a
surprise 50 basis point cut in reserve requirements on November 30, which has
been interpreted by some analysts as a clear signal of a new easing posture for
monetary policy. Nonetheless, other, more conservative analysts continue to
argue that it is too soon to call an aggressive easing cycle. For one, the
rhetoric by top leaders remains quite reserved as evidenced by quotes coming
out of the recently completed Central Work Committee Conference completed on
Dec. 14. For another, the 50bps reserve requirement ratio cut is roughly enough
to keep liquidity relatively stable (and not easier) as bank deposit inflows
have slowed considerably in recent months and caused average bank loan to
deposit ratios to rise.
What to Watch
Credible evidence of timely and
sufficiently aggressive policy easing – enough to prevent a hard landing in the
short term – would include a basket of policy actions implemented before the
end of January, roughly as follows: stimulating higher loan growth in the range
of 1 trillion-plus yuan in December and January 2012 – more or less double what
the September-November 2011 period); further reserve requirement cuts of 200 to
300bps; a fiscal stimulus plan in the range of 1 to 2 trillion yuan; and, last
but not least, a reversal of key real estate restrictions.
Time is of the Essence: Part Two
A commitment in word and action
roughly along these lines is crucial by policymakers in the next weeks, not
months. The nature of credit-fueled asset and investment-led growth bubbles is
that they overshoot on the way up and on the way down. When an easy
credit-fueled asset bubble is in an expansion phase, asset values go way beyond
any reasonable valuation metric based on present value/future cash flow
analysis and economic growth rates may also surpass historical precedent.
This is because in an
investment-led, credit-fueled growth bubble, such as has played out in China
over the past several years, easy credit conditions drive high rates of
investment growth, which drive higher economic growth begging more investment,
and so on, in a self-reinforcing cycle. Unfortunately, when a credit bubble
unwinds in a debt deflation bust, the same cycle occurs in reverse: asset
prices overshoot past fair value on the downside and growth also declines and
suffers as distortions sown during the boom are worked out – or not – by the
private and public sector.
The longer the work out process
takes to play out, with delays typically caused by well-intended government
interventions, the longer the sub-trend growth cycle lasts -- as seen in
Japan’s anemic growth and asset value performance since the stock and real
estate bust in 1989. Japan’s GDP growth has averaged a puny 1 percent a year
since 1989 while the stock index remains mired in a secular decline, falling
from a high of 39,000 in 1989 to current levels around 5500.
It is very difficult, if not
impossible, to reverse a self-reinforcing debt deflation cycle once it reaches
a critical mass of momentum no matter what policy-rabbits decision makers can
pull out of their collective policymaking hats. Thus, timing is everything.
In order for policy reflation
to work, it is imperative that Chinese leaders change gears soon and pursue
timely and aggressive deployment of reflationary policies including a
combination of monetary, fiscal and administrative measures as outlined above.
The 50bps cut in reserve requirements on November 30 is a step in the “right”
direction, but not nearly enough to make likely a reversal of emerging signs of
a sharp softening in the Chinese economy in general and in particular in the
real estate market.
Adjusting expectations for the
timing and scope of the “easing” bogies listed above based on progress or lack
thereof, we will continue to raise (or quite unlikely lower) our odds of a hard
landing, especially if the A-share market continues to flounder reflecting
tight domestic liquidity conditions.
No Way Out
Given the leadership transition
cycle upcoming in 2012 and 2013, policymakers may be willing -- and still able,
although the clock is ticking fast --to do whatever it takes to avoid a hard
landing in the first half of 2012 even if it means compromising on inflation
fighting, which it must. That is why it is necessary to stop short of assuming a
hard-landing in 1H2012 is inevitable.
But Chinese policymakers must
act quickly and deploy aggressive reflationary policy measures as soon as
possible lest a larger than anticipated growth slowdown manifests into a
self-reinforcing and irreversible downward cycle characterized by slowing
growth, eroding public confidence, currency depreciation, bank deposit flight
and capital flight – all of which will facilitate an unavoidable domestic
credit crunch and, ultimately, a hard landing for the Chinese economy. In a
weakening currency and capital flight scenario, policymakers can print all of
the money they want to reflate the domestic economy, but the liquidity will
merely flow offshore.
Sam Baker
AsiaSentinel
Business & Investment Opportunities
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