CDT Money: Waiting For The Bottom

The People’s Bank of China announced a 50 bps cut in the reserve requirement ratio (RRR) for commercial lenders on Saturday as it stepped up efforts to boost growth amid signs of a weakening economy. The second such cut this year, which will officially go into effect on May 18, is intended to give local banks more breathing room to lend after the central bank announced on Friday that total deposits had fallen in April. But it also comes after a week of other dismal economic data releases, including signs of slowing global and domestic demand, lower power consumption and the weakest industrial output growth in three years.

China’s trade partners feel the pain of “deceleration” in both directions, including the ports of Southern California. And with China’s economic growth under siege both at home and abroad, economists don’t believe Saturday’s RRR cut will solve the economy’s problems by itself and instead see it as a prelude to a broader economic stimulus policy by the government. From The New York Times:

“We expect more aggressive delivery of policy stimulus via quantitative easing, substantial tax breaks, fiscal spending and investment deregulation in the coming months to ensure a soft landing,” Qu Hongbin, the co-head of Asian economic research at HSBC, said in a report.

Interbank lending rates have been sinking in China, a sign that the banks have plenty of spare cash even without being told that they can hold smaller reserves.

The cut in the reserve ratio should be seen “more as a signaling device used by the government to show its willingness to loosen policy in light of the significant weakening in activity growth in April,” Yu Song, an economist at Goldman Sachs, wrote in a research report.

The state-run China Securities Journal hinted on Monday that any broader economic stimulus package would likely involve another RRR reduction, but MarketWatch’s Craig Stephen pointed out that attempts to expand lending might be met by a “demand deficit” as the amount of profitable investment opportunities continues to shrink. Still, Reuters reports that economists had already rushed to update their growth forecasts after the week’s bad news:

“We were wrong and we revise down growth forecasts,” was the straight-to-the-point heading in the message line of an email sent to clients by Ting Lu, China economist at Bank of America/Merrill Lynch in Hong Kong after Friday’s torrent of data drowned his call of a Q2 GDP bounce to 8.5 percent.

He now expects growth of 7.6 percent in Q2 and 8 percent for the year versus 8.6 percent previously. The consensus forecast for 2012 growth in the benchmark Reuters poll before Friday’s data was 8.4 percent.

Lu is struggling to understand why the April data was so far away from market expectations and thinks a new reporting system requiring China’s 700,000 biggest manufacturers, representing 90 percent of the total value added in the factory sector, to submit numbers directly the National Bureau of Statistics in Beijing – rather than local offices – might be the root cause.

Whatever is behind the drop-off, the new consensus view is that Beijing will have to raise its game to stop the rot.

With research analysts across the street cutting growth forecasts, and with the ongoing political standoff in Greece weighing even further on the confidence of investors, mainland stocks fell to their lowest level in three weeks on Monday and slid again on Tuesday to a 1-month low.  China’s Ministry of Commerce poured fuel on the fire by announcing on Tuesday that foreign direct investment (FDI) declined for a sixth straight month in April. Whether because of a lackluster global economy or a slowing Chinese machine, or both, one economist told Bloomberg TV that all signs seem to point in the same gloomy direction:

“Trade data was bad, production data last week was bad, and this time FDI is also pointing to the same direction,” Zhang Zhiwei, chief China economist with Nomura Holdings Inc. in Hong Kong, said in a Bloomberg Television interview today. The reports show a “very weak economy at this moment,” with chances of an interest-rate cut rising though “still below 50 percent,” Zhang said.

In his Bloomberg View column, William Pesek writes that “nobody beats the system” and reminds anyone who hoped for unimpeded economic growth in China that “no industrializing nation has ever avoided a financial crisis.” Even The China Daily noted that the slowing growth rate is “within expectations” though not indicative of a hard landing. Tsinghua University’s Patrick Chovanec told The Financial Times that despite the desire of many to write off a slow first quarter as “just a little dip,” April’s data shows that “those forecasts were mostly a triumph of hope over reason”:

“China’s been riding an investment boom over the last three years that everyone recognised was unsustainable and now we’re seeing what unsustainable looks like,” Mr Chovanec says. “The unravelling of this investment boom is happening with nothing to replace it and that means China is in store for much lower GDP growth than we’ve become accustomed to.”

Spotlight: State-Owned Monopolies

China made another move to limit the dominance of state-owned enterprises this week, part of its plan to structurally reform the economy, as the Supreme Court established new rules that will open the door for more antimonopoly challenges and allow plaintiffs to more easily make their case. From The Wall Street Journal:

The rules, which will go into effect June 1, are meant to “improve the competitiveness of enterprises and promote the healthy development of a socialist market economy,” said a court statement issued Tuesday.

Legal experts say the rules will lower the burden on plaintiffs to prove the existence of a monopoly. They also appear aimed at addressing mounting pressures from both inside and outside China to scale back the power of the nation’s vast state-owned firms and make way for more competition from private companies.

The new rules say plaintiffs in antitrust cases can now prove a defendant’s market dominance by using a defendant’s old and existing company statements, press releases and website information that state its leading market position. Third-party market analysis can also be used if agreed on by plaintiffs and defendants, and if an agreement can’t be reached the courts will appoint an expert, the rules say.

Luxury Brands Still Growing:

Amid the market slowdown, The China Daily reports that international luxury brands such as Gucci recognize the need to retool their China strategy:

“Yes, the rate of expansion will be slower than in the previous years,” Patrizio di Marco, president and CEO of Gucci, told China Daily.

Some other luxury brands, including LV and Chanel, will also slow their expansion in China starting this year, business analysts said.

Rather than just expanding their stores in China, the leading luxury brands are starting to pay more attention to upgrading their current stores.

Despite the slowdown, Gucci will relocate and enlarge some of its stores in China.

“It’s not (store) numbers, it’s how you engage with your customers that counts,” Di Marco said.

While growth in the sector may continue to slow, and several potential roadblocks exist, a new report by CLSA Asia Pacific Markets expects that China will continue to lead the global luxury boom. From The Wall Street Journal:

Mainland-Chinese customers generate roughly one-third of Gucci and Prada’s world-wide sales, he added, and it’s not uncommon for rich Chinese to spend one-quarter of their disposable income on luxury goods.

They are also, Mr. Fischer pointed out, becoming more discriminating. Gucci and other retailers are stocking fewer logo-emblazoned items in their Chinese stores as shoppers begin to gravitate to more subtle displays of wealth.

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