China Encourages Debt as Manufacturing Shrinks
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Chinese economic activity continues to decline as the government encourages borrowing money to fuel growth.
According to the HSBC flash Purchasing Managers’ Index (PMI), manufacturing activity shrunk again in June, with a reading of 49.6. Some pundits are cheering the fact that the reading is up from May, when the reading was 49.2, and beat expectations by 0.2 points, but several economists are still warning that the contractionary trend remains intact and is indicating that Chinese growth is likely to fall short of its target for the year.
Chinese economic activity continues to decline as the government encourages borrowing money to fuel growth.
According to the HSBC flash Purchasing Managers’ Index (PMI), manufacturing activity shrunk again in June, with a reading of 49.6. Some pundits are cheering the fact that the reading is up from May, when the reading was 49.2, and beat expectations by 0.2 points, but several economists are still warning that the contractionary trend remains intact and is indicating that Chinese growth is likely to fall short of its target for the year.
The survey also noted that employment continues to fall in China’s manufacturing sector, although there were improvements in new orders and exports. However, export growth was still negative and layoffs rose to the highest rate in over six years.
According to Markit economist Annabel Fiddes, manufacturers will likely continue to lower headcount, which in turn will curb domestic demand. This is a problem for Chinese policymakers, who have been trying to transition the economy from an export-driven to a domestic-driven market.
Lending Boost
Chinese policymakers are turning to debt to fuel growth, which is already showing signs of affecting the economy. According to the HSBC report, retail and property activity are rebounding—two sectors that are increasingly reliant on consumer credit.
To drive growth further and encourage more indebtedness in the country, China has recently relaxed rules on lending. The country’s regulators have also relaxed margin requirements for stock trading. According to a research report from an investment bank, margin debt has risen 123% in 2015 and now represents 3.4% of the market capitalization of the Chinese markets.
A year ago, China relaxed lending standards by easing the loan-to-deposit ratio required by banks—a move designed to encourage more borrowing for home buying and use of revolving credit. More recently, the State Council of China is considering abandoning a rule that requires commercial banks to lend no more than 75% of their deposits.
Critics warn that the move is encouraging a credit bubble in China, which is likely to have disastrous consequences if property values continue to fall and more homeowners become insolvent. They note the moves echo America’s expansion of credit from the 1980s to the mid-2000s, which partly contributed to the housing crash in 2008.
China also cut interest rates for the third time in six months in May, which has also encouraged more debt-fueled consumption and investment. Analysts warn that the move is largely ineffective, as real interest rates remain over 10% and profit margins on activities remain around 3%.
China’s stock market has also stalled. After rising 150% in a year, the market has fallen 6% from its top. Some analysts warn that an equity bubble fueled by unsophisticated retail investors is developing, but it is difficult to determine exactly when the bubble will burst.
