Thursday, April 23, 2009
Dear All, my latest blog post on RGE Monitor
Victor Shih | Apr 23, 2009
I have been getting a wave of bullish sell side reports about how the stimulus program launched late last year is having an unexpectedly good impact on leading indicators in China. Before we draw quick conclusions about how rosy everything will be, let's step back and examine what these figures are actually telling us. In essence, most of the benefits of pumping 5 trillion into the economy are temporary. When this pace of lending slows, many benefits will reverse into major problems.
First of all, I am more or less repeating some points that Mike Pettis raised in earlier notes. Also, unlike many sell side analysts, Stephen Green at Standard Chartered has issued several reports that give a more comprehensive view. Let's look at the latest figures. In conjunction with the stimulus program, the banks issued nearly 5 trillion RMB in new loans in the first quarter, a historically high level. Because there was basically no share issuance or new corporate bond issuance, the 5 trillion from the banks was really the main engine for 1Q 2009. The 5 trillion is almost the size of the US fiscal stimulus package and basically 1/6 of China's 2008 GDP. As far as I know, this is the largest monetary easing in this period of time as a share of a country's GDP (that didn't go into writing off bad debt, that is). Impressive indeed, but what did China get in return?
1. To be sure, fixed asset investment grew by 25+%, which was one of the intended effects of monetary easing of this magnitude.
2. Official PMI, which mainly reflects sentiment among SOEs or state corporation, went back into positive territory, but private sector PMI was still in negative territory at the end of March.
3. There has been a pretty impressive stock market rebound in the A share.
4. The housing market is showing some sign of life after a long winter. Sales in many major cities are going up significantly, even driving up prices in some cases.
So far so good, BUT...
When we look at figures for non-investment economic activities, things do not look good at all. In fact, it is down right disappointing after pumping 5 trillion into the economy.
1. First of all, export and FDI continue to fall at a pretty fast pace, which can't be helped.
2. More alarming, inventory for many industrial goods continue to build UP! According to a recent note by Stephen Green's team, refined oil inventory is up over 35% YoY as of the end of February.
3. Coal inventory seems to have gone down, but that's because many coal mines have ceased to operate. The 21st Century Business Herald reported that 50-70% of mines are "resting" for the moment. Iron ore mines are facing the same problem as international iron ore now costs less than domestic ore.
4. Electricity usage continues to be in negative territory.
Steel consumption has picked up somewhat from a collapse late last year. However, I think the problem there is continual over-capacity. The central government didn't want any major steel firms to go under, so they are spending billions to "merge" a bunch of steel firms. For example, Bao Steel based in Shanghai will buy up several steel producers in the Jiangsu/Zhejiang area. This maintains the over-capacity in the sector and will put upward pressure on inventory.
In electricity generation, there is rumor of a ,CIC2, a mega company that will buy up distressed electricity producers and coal mines from across China, boosting the on-going consolidation financed by bank loans. In the airline industry, billions have been injected into airlines to keep them afloat amidst disastrous bets on world oil prices.
There is then the widely cited figures of 12% increase in urban income at the end of 2008 and increase in car sales in first quarter. In the first instance, I have no idea how the income figures were produced, but they almost always miss migrant workers, who are also urban residents. On the car sales, China Economist already points to a recent FT article which questions whether sales of minivans will help car company profitability. Finally, employment, which supposedly was the main point of the stimulus, was only marginally improved by the 5 trillion. Most large projects haven't gotten going yet as land still needs to be procured. The biggest employment impact was that the 5 trillion prevented the mass bankruptcy of hundreds and perhaps thousands of firms. However, some firms are staying alive by laying off or furloughing workers, like the coal mines.
So, really, when it comes down to it, the 5 trillion bought:
1. some psychological relief
2. some more sales of real estate, thus delaying the bankruptcies of many developers
3. an upbeat stock market, for a while
4. prevented the bankruptcy of numerous state firms, especially in the airline, coal, electricity, and steel sector
The most alarming thing is that these "positive" effects of pumping money into the economy lasts only as long as the money keeps flowing. If for whatever reason, the central government decides to slow down the pace of lending (and there are signs they are thinking of doing so), ALL of the above benefits will collapse relatively quickly. Imagine; if the flow of funds slows significantly, the psychological relief will disappear quickly, as will short-term loans to developers; the upbeat market sentiment will follow as speculative funds withdraw suddenly from the market. SOEs, which are building UP their capacity and inventory as we speak, will face growing losses from depreciation and deflationary pressure on output. Without free flow of bank loans, they will begin to default on their previous loans. Speculative demand for real estate will also collapse, given that inventory is expected to reach over 1 billion sqmtr some time in 2009 (again citing SCB report by Green et al.).
What does this mean? The central government cannot stop or even significantly slow this pace of lending until export picks up in a significant way, else the bubble will burst. This is a race against time. At some point, this pace of lending will lead to a serious NPL problem or inflation, or both. If by that point, export and domestic household consumption remain anemic, I am not sure what options the central government will have.