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China announced its first quarter GDP growth in April. The economy slowed to 7.4 percent on a year-over-year basis in the first quarter of 2014, down from 7.7 percent on the same basis in the fourth quarter of 2013, slightly higher than the market expectation of 7.3 percent. Comparing the first quarter of 2014 to the fourth quarter of 2013, the economy grew only 1.4 percent, down from 1.7 percent in the previous quarter.
China’s monthly economic indicators looked much weaker than the headline first quarter GDP growth, however. On a year-over-year basis, the industrial production growth rose only 8.7 percent, retail sales by 12 percent in the first quarter, and fixed asset investment by 17.8 percent in the first quarter. These monthly economic indicators suggest that China’s economy could have only grown by 7.0 percent in the first quarter of 2014.
Despite such a weak performance, it appears that an upward cyclical rebound is already underway.
First, the latest inventory data indicated that a fast decline in inventories has taken place. Coal inventories have declined at power plants and also in the port of Qinhuangdao, the major port for coal transportation in China. The latest data suggest that China’s power plants hold around 18 days of coal demand, down from the 23 to 25 days early this year. In addition, thermal coal inventories at the port of Qinhuangdao decreased by 28 percent in the third week of March from the peak level of 5.9 million tons early this year. In addition, steel inventory fell by 6.7 percent in late March from the peak level in late February.
Second, external demand is expected to pick up significantly as shown in China’s March purchasing managers’ index (PMI) data. The export order index picked up strongly in February and March in both the official PMI and the HSBC PMI, in line with the improving outlook for the advanced economies. In the meantime, the employment index of the HSBC PMI also rebounded significantly. This is crucial for employment, as the export sector creates about 130 million to140 million jobs. The port throughput data and a recent field study by the Australia and New Zealand Banking Group (ANZ) in Ningbo, a coastal city in Zhejiang province that is largely dependent on exports, are also consistent with a pending pickup in China’s exports.
Third, the acceleration in government spending will provide some impetus to the economy in the coming quarters. Historical data show that the number of newly started projects usually begins to accelerate following the National People’s Congress and will peak in the middle of the year, coinciding with the pace of China’s fiscal spending cycle and steel inventory cycle.
Indeed, China will continue to maintain a "proactive" fiscal policy this year, indicating that the government has room to increase investments to counter the economic slowdown. For example, the central government released an ambitious shantytown renovation program this year, with a goal to finish 470 million units of shanty housing renovation, which will result in a one trillion renminbi (RMB) investment ($160 billion) versus a RMB 300 billion ($48 billion) investment last year. In addition, in mid-March, four railway projects were approved, with total investment amount at RMB 140 billion, and three of them are in less developed areas.
But the strength of the cyclical upturn will hinge on whether the People's Bank of China can permanently lower the funding costs facing enterprises. Only a permanent cut in the required rate of return could help reduce firms’ funding costs in the near term.
Looking ahead, whether the cyclical upturn can be sustained beyond the second quarter will depend on whether the People's Bank of China can meaningfully lower the very high lending rates facing enterprises. At this stage, the weighted average for the 1-year lending rate is 7.34 percent, while firms' profit margins are hovering at less than 5 percent and are expected to fall further. In addition, China’s monetary supply (M2) growth slowed significantly to 12.1 percent year-over-year in March. This is the first time that M2 growth moderated below the announced target of 13 percent since April 2012, indicating that the deleveraging process in financial institutions continues. The ongoing deleveraging will tighten China’s credit conditions further.
Since mid-January the People's Bank of China has used double interventions in both the foreign exchange market and the money market to engineer a depreciation of the renminbi and a fall in money market rates. Indeed, the sharp increase in foreign exchange reserves by more than $120 billion in the first quarter confirmed this observation. This also means that without intervention the renminbi is still under pressure to appreciate. Since such foreign exchange interventions cannot last for long and could be self-defeating, the currently relaxed monetary policy conditions could fade quickly once the foreign exchange intervention stops.
While the central bank will continue to shun a required rate of return cut while maintaining frequent open market operations to lower money market rates, they will probably not be useful in lowering China’s bank lending rates much. If low money market rates do not lead to a lower lending rate, and if growth falters again after the second quarter, a cut of 50 basis points in the reserve requirement ratio will likely take place in the third quarter.
Short of any meaningful monetary policy easing, it will be difficult for China to achieve its growth target of 7.5 percent. Therefore, the growth forecast of 7.2 percent for 2014 is likely to hold.
Li-Gang Liu, a visiting fellow at the Peterson Institute for International Economics, is chief economist for greater China at the Australia and New Zealand Banking Group (ANZ) in Hong Kong.
