CDT Money: More Signs of a Slowdown

Despite suggestions last week that the yuan exchange rate had reached equilibrium and hints of possible liberalization in its trading range, officials at the People’s Bank of China set the yuan’s U.S. dollar reference rate at a record high on Friday as macroeconomic concerns continue to mount.

The move by China’s central bank reflects an effort to mitigate selling pressure after the release of preliminary but disappointing manufacturing data, as a number of global currencies sensitive to Chinese growth fell against the dollar on Thursday when an unofficial reading showed that Chinese factory activity had hit a four-month low. Following dismal trade data for February, including a record trade deficit, the 48.1 level indicated by the HSBC flash purchasing managers index (PMI) frightened global markets. From Reuters:

Investors immediately hedged exposures to trades betting on a rebound in global growth. Brent crude oil shed half a percent, Hong Kong’s Hang Seng stock index sank 0.1 percent into the red to reverse early gains of 0.7 percent and the Australian dollar skidded to a two-month low.

Broad-based weakness in the five key components that generate the headline index level surprised analysts, particularly those who had anticipated a clear cut rebound in factory activity in March after the Lunar New Year disrupted output in the first two months and distorted the data.

“This data suggests there’s something more profound at work, that it’s not just a Lunar New Year problem and that it’s not just affecting exports, but domestic demand,” Tim Condon, chief economist and head of Asian research at ING in Singapore, said.

The recent string of worse-than-expected data has further stoked fears of a hard landing for China’s economy. Even The People’s Daily ran an article over the weekend which forecasted a “more complicated and severe” export environment in the coming months. As part an ongoing series in the Guardian titled “China: the next generation,” Tsinghua University’s Patrick Chovanec and Andrew Babson of Beijing-based consultancy Gavekal-Dragonomics debated the possibility on Thursday. From Chovanec, who argues that a hard landing has already begun:

Dear Andrew,

There really are two related but distinct things people have in mind when they talk about a “hard landing” for China. The first is a rapid deceleration of GDP growth – below, say, 7%. The second is some kind of financial crisis. I think we’re already seeing some signs of the first, and the second is a bigger risk than most people appreciate. For the past several years, most of China’s GDP growth has come from a massive investment boom fuelled by easy credit. Unless China sees a major increase in export demand – highly unlikely – or a huge shift towards domestic consumer spending – a lot easier said than done – the only way to hit 8-9% growth is to keep that investment boom going like gangbusters. The problem is, all that easy credit is generating bad debt and inflation. The state banking system can brush bad debt under the rug, but the more bad debt gets rolled over, the less capital is available to fund new projects. The only way to keep the investment boom going is to dramatically expand credit. That would spark inflation and further distort the economy, which China’s leaders know they can’t do. They’ve painted themselves into a corner, and something has to give. Even though the money supply is expanding at a fairly generous rate it’s still not enough. That’s why real estate is collapsing and ambitious public works, like urban subways, are hobbled by lack of funds. Last year, out of China’s 9.2% real rate of GDP growth, five percentage points came from investment in fixed assets. If China builds all the roads, bridges, ports, airports, high-speed rail lines, condos, villas, etc this year that it built last year – an absolutely astounding amount of construction – but NO MORE, GDP growth would fall to just 4.2%. That’s a “hard landing” by anyone’s definition…

A senior economist with a Chinese government think-tank gave a press conference on Thursday in which he insisted that the government had “set aside enough space for policy maneuver” in the event of a worst-case scenario. But whether or not China can cope with what the official referred to as the “extreme risks” of a sharper global downturn, even a moderate slowdown will hit foreign businesses who have turned to China for growth in recent years. According to an annual survey by the American Chamber of Commerce in China, nearly half of respondents rated the nation’s economic slowdown as the biggest risk facing their business this year. From The Wall Street Journal:

The survey showed that 46% of respondents say China’s slowdown is among their greatest risks in that market, up from 31% a year ago. Only 16% expect China revenue to grow by one-fifth or more, compared with 26% who expected that in 2011, the survey, which included more than 300 of the organization’s members at the end of last year and was released publicly on Monday morning, showed.

Ted Dean, AmCham China’s chairman, noted that the survey still showed that 76% of members expect revenue from China to grow this year, while only 16% expect flat revenue and only 8% expect revenue to fall. “Companies [in China] are for the most part doing well,” he said. But he added the results “signal increasing concern over the shape of the economy both domestically and globally.”

Spotlight: Property Danger?

During a trip to Beijing last week, China scholar Nicholas Lardy warned that analysts have overlooked the possibility that China’s property market could fall harder than expected and have a contagion effect on China’s economy. From The Wall Street Journal:

“A lot of people are in denial here about whether there could be a significant property correction,” said Mr. Lardy, who was visiting Beijing as part of the National Committee on U.S.-China Relations. “The downside risk is a period of declining growth, not for a few quarters but for a few years.” Mr. Lardy didn’t estimate the rate of economic growth under such an occurrence.

The Chinese government has been pressing to reverse years of rapid increases in property prices, especially in luxury apartments. It’s been having some success. Property sales declined by 14% over the first two months of year, compared to the year earlier period, said UBS, with prices in 70 major cities declining in March compared to the previous month.

It’s possible that Chinese officials could hit the brakes too hard. But Mr. Lardy, an analyst at the Peterson Institute for International Economics in Washington D.C., said that other factors could pop the real-estate bubble rather than letting it deflate gently. Stock market reforms that give people greater confidence that the markets aren’t rigged could boost demand for securities, for instance.

This week, Bloomberg reported that Chinese property developers are setting up funds to raise money from the private sector. As the government has tightened its lending to real estate companies in an effort to cool the property market, developers are now turning to alternative sources of funding.

U.S. Market Open for Chinese IPOs?

Guangzhou-based online discount retailer Vipshop Holdings saw its U.S. initial public offering flop last week, as it completed the first IPO by a Chinese company into the U.S. since last August, with the shares falling 15 percent on the first day of trading after the US$71.5 million offering raised 39 percent less than planned. The outcome reflects the skepticism that persists among western investors toward Chinese companies, both for their poor performance on U.S. stock exchanges and following fraud allegations that surfaced against Sino Forest and others last year. From Bloomberg:

“There’s still some negative sentiment toward Chinese companies,” Kevin Pollack, managing director at Paragon Capital LP in New York, said by phone on March 23. “If the growth rate of China slows down, that could make these companies even less attractive,” said Pollack, who invests in U.S.-listed Chinese stocks.

Just three of the U.S.-listed Chinese companies that raised funds through IPOs in 2011 were trading above their offering price as of March 23, data compiled by Bloomberg show.

The slump in Chinese Internet companies since their IPOs “is still fresh on people’s minds,” said Tim Cunningham, who helps oversee $83 billion, including Chinese stocks, at Thornburg Investment Management Inc. in Santa Fe, New Mexico.

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