Making Sense of China’s Mixed Signals

By: QFinance   Date: 17 October 2012

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The Chinese economy is no longer blistering hot but it has been sending out mixed signals about its state of health. From deteriorating manufacturing output and falling prices to unexpected rebounds the following month, how can we make sense of Chinese contradicting economic reports?

Making Sense of China’s Mixed Signals

Which way is the Chinese economy headed?
Photo Credit: Alex Goldmark

A hard landing in China has been predicted by "China bears" ever since word of China's property bubble first emerged after the 2008 crash. Those pessimistic about the chances of the Chinese economy overcoming all the challenges facing it have suggested that a failed Chinese economy would be a very substantial check on global growth, possibly plunging advanced economies into a Great Depression style era. However, while the latest statistics to come out of China are disappointing, the signals are at worst mixed, and are a long way off heralding some kind of catastrophe.

There is no doubt that China's manufacturing output deteriorated through June 2012. The HSBC China Manufacturing Purchasing Manager's Index (PMI) fell to 48.1 in June, down again on May's fairly dismal reading of 48.4. As Francesca Freeman and Sarah Kent note in their recent Wall Street Journal article, June's results make this the eighth month in a row that China's PMI has come in at under 50 (any PMI reading under 50 signals a contracting rather than an expanding economy). According to the WSJ, June's poor PMI was driven by a continuing decline in export orders, the lowest since March 2009.

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Slowing global demand has had a marked impact on commodity prices which have moved a long way down from recent highs. Oil is now at its lowest point for one and a half years, while copper has hit a six month low at $7,219.50 a metric ton. The last 12 months or so have established a very strong correlation between weaker Chinese economic indicators and plunges in non-agricultural commodity prices.

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There are, however, a number of policy options available to the Chinese government that will go some way towards taking the sting out of any marked pullback. In particular, China could look to step up infrastructure investment. There is now plenty of incentive for the government to act. According to Bloomberg, industrial profits in China for the first five months of 2012 show a 2.4 percent decline from the same period a year ago, falling to 1.84 trillion yuan, according to the Chinese Bureau of Statistics.

However even with all this negativity, the Chinese economy still managed to expand by 8.1 percent through the first quarter of 2012. Reuters cites Jia Kang, Director of the Research Institute for Fiscal Science at the Chinese finance ministry as saying that Beijing is cautiously optimistic about the country's economic prospects since it has plenty of scope to shore up economic activity by further loosening monetary and fiscal policy. The Chinese government expects the economy to stabilize in the third quarter of 2012 and says it is still on target to achieve its target annual growth rate of 7.5 percent for 2012. This would be well down on the figure for 2011, but China has been trying to take some of the heat out of economic growth in order to combat rising inflation.

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The challenge it faces, however, is to damp down inflation without overly damping down economic activity since it is generally agreed that China needs to grow at 7 percent just in order to create enough jobs to avoid escalating social unrest. Moreover, Beijing's fate is hardly entirely in its own hands, since the Chinese economy is being hammered by the European sovereign debt crisis and by a slowdown in the US. On June 7, China cut interest rates by 25 basis points, the first reduction since 2008, and further cuts are now likely. Bank capital reserve levels have also been loosened and are expected to be reduced still further, to stimulate bank lending. In addition, Beijing is expected to step up investment in infrastructure.

Interestingly, Lou Jiwei, chairman and chief executive of China's huge sovereign wealth fund, China Investment Corp (CIC) recently told the Wall Street Journal in an interview that China was not alone in struggling to find a balance between restructuring the economy (moving it away from being hugely focused on exports to being more focused on domestic consumption) and growth. The US, he pointed out, had the reverse problem, being way too dependent on massive domestic consumption and too little focused on export. "Everyone knows that the US economy shouldn't be so reliant on consumption. More investments should be made. However, markets and policy makers keep watching the consumer index and whenever the savings rates go up a little bit, they get super nervous," he said.

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By Anthony Harrington

Anthony Harrington is an award-winning business and energy journalist, writing regularly for the Scotsman newspaper, the Glasgow Herald newspaper, Financial Director magazine, Pensions Insight magazine, CA Magazine, and a number of other publications. He won Business Finance Journalist of the Year 2006, Institute of Financial Accountants, and Journalist of the Year, State Street 2006 Institutional Press Awards, and was runner up in 2007 and 2008.

China slowdown sends mixed signals is republished with permission from the QFinance Blog. Get the QFinance Dictionary of Business and Finance iOS app for a comprehensive guide to financial terms and expressions.

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