China's Economic Slowdown Fans Hopes Of Policy Easing

 @moranzhang on March 25 2014 12:47 PM
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China’s economy slowed markedly since the start of the year, with multiple measures falling to multi-year lows, prompting Nomura’s analysts to believe that the Chinese government will likely ease both monetary and fiscal policies in the second quarter.

Without easing measures, the chance of the Chinese gross domestic product growth (GDP) dropping below 7 percent – the “lower bound” that Beijing is willing to tolerate -- in the second quarter or the third quarter is above 50 percent, Nomura forecasts in a note published Tuesday.

The HSBC China flash PMI fell to an eight-month low of 48.1 in March, while the domestic and overseas order indexes of the first-quarter corporate survey conducted by the People's Bank of China dropped significantly to 44.4 and 45.4, respectively, their lowest in almost five years.

Another worrying sign is that growth of property investment looks set to slow in coming months, as its leading indicator, property transaction growth, slowed sharply in January and February.

Chinese Premier Li Keqiang said last week investment and construction plans would be accelerated to ensure domestic demand expands at a stable rate.

Beijing has long-term objectives such as rebalancing the economy and short-term objectives such as maintaining growth above 7 percent, and Nomura believes that if short-term objectives are not at risk, the government tends to focus on the long term objectives. But when short-term objectives are challenged, the government usually shifts its focus toward promoting growth.

“We have witnessed this ‘two step forward, one step back’ style of policy swings in the past,” Nomura’s Zhiwei Zhang says.

Zhang sees three sets of possible policy easing measures:

First, on the monetary side, we believe the PBoC needs to send a stronger signal of policy easing. We believe a banks' reserve requirement ratio (RRR) cut of 50 basis points in second quarter and another 50 basis points cut in the third quarter are likely. The probability of an interest rate cut is rising as well, although it is not yet part of our base case. Credit supply will also likely rise, as measured by bank loans and total social financing.

Second, on the fiscal front, we believe fiscal spending will increase, so on a monthly basis the actual central government fiscal deficit may widen.

Third, in the housing market, policies may loosen in de facto terms. The central government has decided to give local governments more freedom to choose housing policies that are appropriate for local circumstances. This will likely lead to policy easing, as local governments are under pressure to boost local housing markets. For instance, some property developers offer financing for buyers to cover part of their down payment, according to Chinese financial news. Such offer circumvents the down payment ratio requirement by the banks.

Unlike the 4 trillion-yuan ($646 billion) fiscal stimulus package unveiled by the government at the height of the global financial crisis in November 2008, easing this time around is likely to be communicated in a more subtle way.

“Policymakers do not want to give the impression they are embarking on wholesale easing, as it risks reigniting excesses in shadow financing, local government financing vehicles (LGFVs), property and hot money inflows,” Zhang says. “The objective is not about engineering a V-shaped recovery, but rather stabilizing growth somewhere between 7 percent and 7.5 percent and creating 10 million jobs.”

However, by focusing on the short-term issue, Beijing would risk raising the possibility of a hard landing in the future.

“In a worst-case scenario, the government loosens monetary and housing policies too aggressively and pushes up consumer price inflation and property price inflation,” Zhang notes. “It may force the PBoC to tighten aggressively again in 2015, which would likely be very damaging to a highly leveraged economy like China.”

Nomura maintains its view that there is a one-in-three likelihood of a hard economic landing commencing before end-2015. The firm defines a hard landing as an abrupt slowdown in real GDP growth to an average 5 percent year-over-year or less over four consecutive quarters.

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