China's Economy Turns a Lot Uglier in April

It Looks Bad Because It Is Bad

A flurry of economic data released today (11 May) shows extreme weakness in the Chinese economy. April's industrial production growth came in at 9.3% year-on-year (y/y), the first single-digit growth rate since May 2009, down a sharp 2.6 percentage points from March. On a month-on-month (m/m) annualised basis—which does a better job of capturing recent momentum—industrial production only gained 4.3%, the worst monthly number since the statistics agency started publishing the set. Worse still, electricity production—a reliable proxy for economic activity—collapsed in April, coming in at 0.7% y/y, down from March's weak number of 7.2% y/y, and at its lowest rate since May 2009.

Investment numbers hardly improve the picture, with headline fixed-asset investment (FAI) sinking to 20.2% y/y for January–April, down from 20.9% in January–March. While not a huge pull-back, there remain some worrying trends. On a m/m annualised basis, it was only 9.6%. Key investment items saw contractions, with government-led investment spending on railways down 43.6% y/y. Even highway investment contracted 2.7% y/y.

The real soft spot of investment, however, is the property sector. Real estate investment pulled back to 18.7% y/y for the first four months, down from 23.5% over the first three. Property developers spent only CNY182 billion (USD28.81 billion) on land acquisitions over the January–April period, a contraction of 13.7% y/y. Startlingly, this was over 15 percentage points below the January–March number. The IHS-adjusted floor space under construction metric showed a contraction of 28.3% y/y in April, while home sales growth was -11.8%.

No good news so far. But, the inflation data, also out today, provide a modicum of comfort. The headline consumer price index (CPI) came down to 3.4% in April, easing from March's 3.6%. This was due to food prices, which came in at 7%, from March's 7.5%. Fresh vegetables, which shot up to 27.8% y/y in April, came down on a month-on-month basis by -5.8%, suggesting a large base effect. The producer price index (PPI), however, provides further cause for concern, continuing its downward trend at -0.7% y/y.

Outlook and Implications

With the exception of inflation, nearly every data point released today was negative. This has rattled the emerging consensus that the first quarter was likely to prove the bottom of the cycle, with softly easing credit growth sowing the seeds of a gradual recovery. Indeed, weaker-than-expected output, weaker-than-expected investment and seemingly-accommodative inflation data set the stage for a strong bout of loose monetary policy.

True, there has been some policy support to date, but it has been very timid, fearful of reigniting inflation. Surveys of credit conditions indicate a broadly improving environment and lower market rates—which ties into better credit-issuance numbers of the first quarter—but a closer look at the credit and interbank markets suggest there remain significant constraints on stronger economic activity. M1 and M2, two measures of the money supply, are weak, with M1 growth at the lowest on record. Although the March renminbi lending number (CNY1.01 trillion) was very large, much of the lending was for short-term working capital loans, rather than medium- to long-term lending, hence reducing its ability to stimulate the real economy. Banks only lent CNY681 billion in April, and non-traditional credit issuance seized up. There was only CNY3 billion in trust lending in April, compared to CNY118 billion in March, according to the People's Bank of China (PBoC). There was only CNY28 billion in bankers' acceptance bills in April as well, compared to CNY279 billion in March.

Normally, when tight credit conditions are constraining growth, interbank markets show the tension. The seven-day repo rate should, if funds were short, be rising as smaller banks bid up rates to access capital. However, banks have increasingly been raising capital through the proliferation of "wealth management products" (WMPs), and reinvesting them back into interbank markets, pocketing a spread. As a result, the three-month SHIBOR has pulled back under 5% over the last two months. Evidence of the increasing flight to WMPs—off-balance-sheet products that provide a deposit rate above that of the mandated rate—comes in the rather frightening form of falling renminbi household bank deposits. Household deposits shrank by CNY637.9 billion in April. The traditional source of deposit growth in China—capital inflows through the current and capital accounts—has been insufficient to counter capital flight into WMPs.

Aside from posing a major regulatory and systemic risk challenge—the trust products that WMPs often feed cannot be "rolled over" as has been done in the formal banking sector—the move into WMPs complicates the PBoC's monetary policy position. The central bank has been forced to become a net provider of liquidity to the financial markets, in stark contrast to its traditional role as a net withdrawer. This explains why the seven-day repo rate has come down considerably over the last week, with market expectations of further reverse-repo operations to provide short-term liquidity in a system drained of its traditional source of inflows.

In short, the banking sector is becoming increasingly constrained in its ability to extend credit to the real economy. With growth slowing sharply and inflation ceding ground, the government needs to step up its action. IHS Global Insight expects a reserve-ratio requirement cut soon, and the government to push more forcefully in its fiscal stimulus. However, the central bank remains an inflation hawk, and fears feeding the economy any more credit than the bare minimum. The April data, though, proves that monetary policy is currently below the bare minimum, and more needs to be done.