China's bad case of data blues will test Beijing

Beijing has so far resisted the temptation to expand credit creation to counteract the slowdown in the Chinese economy, but how long can it keep its finger away from the stimulus trigger?

Everyone thought China’s economy was stabilising during the middle of 2014 after a weak performance during the first part of the year. But many analysts were caught off guard by exceptionally weak economic data in July.

Chinese credit expansion plummeted last month. July’s new lending dropped to 385 billion yuan, or $67bn, from 1.1 trillion yuan, a contraction of 65 per cent. The last time China’s monthly lending was in the realm of 300bn yuan was back in December 2009, when the world was in a deep credit freeze.

China’s total social financing (the country’s broadest measure of lending) also shrank by as much as 546bn yuan last month compared to the same period last year; it dropped to 273bn yuan. New bank bill acceptances also declined by 400bn yuan, which was dubbed as the largest decrease in history.

In light of such a bad set of numbers, the People’s Bank of China took the unprecedented step of issuing an explanatory note on its website to explain why the data was so weak. Seasonal volatility was cited as one of the main reasons.

Apart from weak credit data, electricity consumption also slowed to a mere 3 per cent in July, making it the slowest growth rate in 16 months. Electricity consumption is an important gauge of economic activity in China and had been growing at steady 4.9 per cent on average for the first seven months of 2014.

Fixed asset investment, one of the most important drivers of growth in China, also declined modestly from a 22.4 per cent increase in June to 21.6 per cent. Real estate investment, which makes up 16 per cent of GDP and 33 per cent of fixed asset investment, has been in decline for six months straight.

China’s National Bureau of Statistics explained that property developers are cautious on the back of sluggish demand, the manufacturing industry is still undergoing the process of digesting its excess capacity, and there is also reluctance from heavily indebted local governments.

However, growth in the Chinese export industry, one of the traditional engines of the economy, hit a 15-month high of 14.5 per cent year-on-year. The resurgence is also broad-based across both emerging and developed markets. The data is consistent with a solid recovery in the US, according to investment bank UBS.

Weak credit and economic data have sparked market speculation about whether the central bank will embark on a more aggressive easing policy during the third and fourth quarters. China’s inflation rate has remained steady at 2.3 per cent for the first seven months, well below the official inflation target of 3.5 per cent. There is room for Beijing to unleash more monetary easing.

One of the key contributing factors behind the sluggish demand for credit is the high cost of capital. The average cost of corporate and personal loans stood at 7 per cent during the second quarter, according to Haitong Securities, one of China’s largest domestic brokerage firms.

Jiang Chao, chief macroeconomic analyst at Haitong Securities, says one of the key tasks for the central bank during the second half of this year is to lower the cost of raising capital, according to Caixin. There are several options available, such as cutting the official rate and ordering commercial banks to lower the interest rate for high-quality loans, such as first mortgages.

Though July credit and lending data are especially weak, the central bank probably needs more evidence before it will act. If August data continues to show weaknesses, it would increase the chance of the central bank cutting official rates after September.

So far the central bank has shown a reluctance to cut rates to boost growth. The economy has been addicted to credit-fuelled expansion for the past decade. Chinese companies and local governments have accumulated vast amount of debt. Chinese companies owe more outstanding debts than the US.

The central bank has been experimenting with other unconventional policy tools to inject cash into the financial system without cutting official rates. For example, the central bank has provided one trillion yuan or $171bn to the China Development Bank for renovating the country’s shanty towns through so-called ‘pledged supplementary lending’.

The PSL is a new type of lending instrument backed by collateral that is used to inject liquidity into the market. The central bank has also cut capital reserve ratios of commercial banks that lend certain portions of their loans to credit-starved small and medium-sized businesses.

So far Beijing has resisted the temptation to unleash a large stimulus program and expand credit creation aggressively to counteract the slowdown. The big question is how long will it be able to resist the lure to do that -- especially if the data continues to get worse.