China: Rising domestic demand? Declining domestic demand?

China’s stock markets keep bouncing around, sometimes in synch with the rest of the world and sometimes out of synch. Yesterday it was out of synch as it lost 2.9%, largely because a number of corporations announced lower-than-expected earnings growth. 

Today Chinese stock markets seemed to rejoin the global pack with the SSE Composite rising 2.6% to close at 1765. Last night’s interest rate cuts by both the Fed and the PBoC spurred some limited optimism and especially drove up financial stocks. The 3-year deposit rate was cut by 36 bps (greater than the traditional 27 bps), the 5-year deposit rate was cut by 45 bps (ditto) and the 1-year to 5-year lending rates were cut by 27 bps.

I say optimism is limited because trading today was sluggish and volume very low. We have now closed four days in a row below the supposedly solid support level of 1800, below which (once again) the market could not go. In belated recognition that 1800 was not as rock-solid as they had once thought, the government seems to be backing away from the introduction of short selling and margin trading – a policy it announced a few weeks ago to my great surprise. According to an article in yesterday’s South China Morning Post:

The central government is set to delay the launch of margin lending and short selling amid mounting worries the potentially risky trading methods will exacerbate market turbulence. Sources said the State Council had put on hold plans for the much-anticipated launch next month because of fears the introduction of the practices could send the market into another tailspin.

It is another remarkable about-face for mainland financial regulators, who delayed the introduction of index futures last year after getting cold feet about the impact on the market.

It may be embarrassing for them to have retreated so dramatically, but it is better to be embarrassed than wrong. Hopefully their retreat won’t have added to market fears.

What is more likely to inspire fear is information recorded in an interesting article by Geoff Dyer in today’s Financial Times. One of the things that had surprised me recently was the continued strong domestic demand in September. I had expected that as the buying spree associated with the Olympics wore off, we would see a sharp drop in the growth rate of domestic consumption. So far that hasn’t seemed to happen except in certain big-ticket items, like cars and apartments.

In fact in September retail sales – the best available but not always satisfactory proxy for household consumption – grew at a record pace in nominal terms, around 23% year on year, and with the decline in CPI inflation this translates into even higher relative real terms. But the things that we can measure didn’t hold up as well as that might imply.

Car sales, for example, in September were down around 4% (I am quoting from memory, so the number may be wrong), which is the first time this has happened in many years, and I am hearing that October isn’t going to be much better. Fewer people flew on domestic airlines last month than they did in September of last year. And not only are real estate prices dropping quite quickly, but volume seems to have collapsed.

Yet the September numbers show healthy retail sales growth. Perhaps weakening demand will show up in October numbers. According to Dyer’s article:

Signs are growing that China’s economy could be cooling quicker than expected, with a string of big industrial companies announcing production cuts over the past week. The cuts have come as anecdotal evidence from other companies suggests a surprising weakening of demand in October amid the global financial crisis and a local housing market slowdown.

…”Orders for cars and home appliances have already begun to shrink,” Xu Lejiang, chairman of Baosteel, China’s biggest steelmaker, said last week. Zhou Xizeng, analyst with Citic Securities, said steelmakers were trying to adjust rapidly to uncertainty about demand and an inventory build-up. “The recent drop in production is a sort of psychological panic,” he said.

Executives in a number of other industries also said demand had been unusually weak in recent weeks. But some executives said the slowdown could also reflect shorter-term factors such as customers reducing their inventories because of global uncertainties. “We had been expecting this to pick up a bit after the end of Olympics restrictions on factories, but things have been very quiet,” said the chief executive of the China operations of a large paints company. “We are trying to work out how much is due to weak demand and how much to destocking.”

As I have said many times on this blog, rising inventory is going to be a key indicator of trouble ahead. So far we can find trouble in specific areas, but inventory levels on the whole seem fairly stable. Obviously this will change if we see a real slowdown in demand, but so far the numbers are not disquieting.

On that note a group of about a dozen crack Peking University finance students, mostly graduate students, have recently formed the Guanghua Students Monetary Committee to act as a sort of shadow PBoC, and Logan Wright and I are their advisors. They will meet every Saturday to analyze economic and financial market conditions and the PBoC balance sheet, and to discuss PBoC policy, and one of the things they plan to compile and report on is inventory levels among Chinese corporations. They’ll have their own website up and running soon enough, and I’ll publish the address when that happens, but I expect to be able to use some of their findings in this site.

Finally, before closing I want to flag, for those who are interested, another excellent report from Standard Chartered’s Stephen Green. This one, called “China – How much bang for the fiscal buck” was published on October 27 and starts out:

How much growth can we expect the Ministry of Finance (MoF) to provide over the next few years? With China’s economy slowing, many folk are already breathlessly awaiting a fiscal rescue. In recent notes we have looked at how other governments stimulate their economies, how China organised its stimulus package 10 years ago, and how this coming package might be funded. Today, we think through what such stimulus might mean for GDP growth and the overall economy.

Green attempts to estimate the parameters of fiscal expansion and the amount by which it might boost next year’s GDP growth, and his calculations will surprise many. He figures that an expanded fiscal package might only add 0.5-1.0% more growth in 2009 than it did in 2008. Fiscal expenditures, in other words, are unlikely to make up for any significant slowdown in the economy due to slowing exports, weakening domestic demand, or declining investment unless the expansion is much greater than most think it is likely to be.

I have no ability to forecast or estimate growth based on anything more sophisticated than my previous experiences working in countries that have gone through economic slowdowns with weak balance sheets, and the two tend to be self-reinforcing, so the smartest projections tend systematically to under-estimate growth in rising markets and over-estimate growth in declining. As I have said often enough, I expect to see analysts continuously revise their estimates downwards for the next few quarters, as they have already been doing. Already I am hearing a number of pessimists posit 7% as an upper limit. Yikes!

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About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

Visit: China Financial Markets

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