CDT Money: Tale of Two Economies

Mixed messages continue to emerge about the state of China’s economy, after an official reading of China’s manufacturing sector defied a negative preliminary forecast and signaled a rebound in factory activity in March. From the report, published on Sunday by the China Federation of Logistics & Purchasing (CFLP) and the National Bureau of Statistics (NBS):

China’s manufacturing PMI improved from 51.0% in February to 53.1% in March, the highest in twelve months. The index has stayed above the critical level of 50% for four consecutive months, indicating that the underlying momentum of the manufacturing sector in China has continued to improve.

10 of the 11 sub-indices were higher than their respective levels in the previous month. The new orders index rose strongly by 4.1 ppt. while the new e  xport orders index gained 0.8 ppt. in March. The index readings indicated significant improvement in domestic demand. On the other hand, the input prices index went up from 54.0% in February to 55.9% in March, showing that upstream price pressures have increased.

The report conflicts with a separate and unofficial PMI reading also released on Sunday by HSBC, which showed that Chinese manufacturing activity had hit a four-month low. HSBC’s results, according to its chief China economist, “confirm a further slowdown of growth momentum” for the economy. From Bloomberg:

“As inflation pressures continue to ease, weaker export growth is likely to prompt further easing measures,” said Qu Hongbin, a Hong Kong-based economist for HSBC. “Once the easing measures filter through, growth is likely to start bottoming out in the second quarter and rebound modestly in the second half.”

HSBC forecasts reserve-ratio cuts of at least 1 percentage point in the first half as well as additional tax breaks and fiscal spending, Qu said.

The two reports sample different sections of China’s manufacturing landscape, with HSBC focusing on small and medium private businesses and the official report drawing data from large state-owned enterprises, and together they present what Forbes calls a “schizophrenic view of the national economy.” But even as the official report recorded a steady expansion of output in 14 of the 21 industries surveyed, the state-run China Daily notes that the data does not mitigate the concerns of China’s economists:

The March PMI indicated that economic growth was rebounding at a faster pace thanks to the increase of new overseas orders amid the easing European debt crisis, according to Zhang Liqun, a senior economist at the Development Research Center of the State Council.

A statement from the central bank released on Saturday night showed that the government will maintain a prudent monetary policy.

“Although the European debt crisis is easing, there are still uncertainties in the global economy,” the statement said.

“But economic growth may still slow in the coming months because there is a gap between the PMI figure and the real business situation,” according to Zhang.

Others, including The Wall Street Journal’s Tom Orlik, pointed to seasonal factors in explaining the rebound in government PMI:

[…] On average since 2005, the CFLP’s PMI has bounced 3.1 points from February to March. That probably reflects failure to adjust for the impact of the lunar New Year, which has a negative impact on manufacturing in January or February, only for activity to rebound after the holiday is over.

The CFLP team says that they do seasonally adjust their data. But the repetition of the March bounce in the latest numbers suggests they might not be seasonally adjusting it enough.

One PMI in contractionary territory and the other bouncing on seasonal effects means the March data does not provide quite the reassurance on the trajectory of China’s growth the markets wanted to hear.

Regardless of the reason, Reuters reports that Sunday’s data did little to answer questions over the ability of Chinese policymakers to orchestrate a soft landing for the economy. And while the government pledges a “prudent monetary policy,” analysts and investors are left looking for more concrete signs of easing before accepting that growth has bottomed out in China.

Spotlight: Wenzhou

China’s state council approved a series of financial reforms as part of a pilot program in Wenzhou, an entrepreneurial hub which saw a number of private businesses suffer from funding shortages as the government tightened lending practices to cool inflation and an overheated property market. The trial policy will not only allow Wenzhou residents to make direct overseas investments, but the China Daily says that it will also help to standardize and regulate private fundraising in the credit-squeezed city:

Wenzhou was chosen because it is a prosperous center for small and medium-sized enterprises. But these smaller businesses have frequently complained about the difficulties they encounter trying to get loans from the banks following the credit tightening measures introduced by the central bank. The inability to access formal finance led to a proliferation of underground lending companies keen to fill the gap and lend money with exorbitant rates of interest.

These usurious rates led to many defaults when the economy started to slow down and government measures took the heat out of the property market. But there are still many practical problems that need to be solved to ensure the reform meets its objectives. For example, what role should the local authority play and how to design a mechanism that can give full play to the flexibility of private capital?

This flexibility is the advantage private finance companies have over their State-run counterparts. Private loan organizations can take various forms, such as equity funds, village banks, loan companies and capital management companies.

However, the government needs to establish strict entry requirements and transparency. All qualified private capitals should be registered and supervised, as the stability and order of a well-performing private finance market actually benefits both lenders and borrowers in the long run.

One Wenzhou official told The China Daily that the experiment could be expended to Shanghai and Tianjin, a scenario that would lend more weight to the policy. For now, according to The Wall Street Journal, finance and business leaders in Wenzhou welcomed the moves even as one outside observer cautioned that the pilot program represents a baby step in the grand scheme of policy reform that China must implement:

Eswar Prasad, a China scholar at the Brookings Institution, said that the government is concerned that the informal banking sector has been gaining so much steam that it could “pose risks to overall financial stability” by eating away at the depositor base of the big banks. That’s why, he said, “they are taking steps to bring these informal banks under the regulatory umbrella.”

Even if it begins to roll out some of these initiatives elsewhere, China still has major work to do. Mr. Prasad said China still must liberalize interest rates, so that China’s largest banks respond more to market forces, or proposed changes won’t be sufficient. “These steps to formalize the underground banking system are no substitute for more basic financial-sector reforms,” he said.

There was no indication from the State Council statement that the government was yet ready to move on interest-rate liberalization, even though central-bank Gov. Zhou Xiaochuan said recently that the time was “basically ripe” for such a move. The People’s Bank of China reports to the State Council.

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