The current policy regime may continue to boost economic output in the coming months. Uncertainty about the economic outlook stems from likely policy choices by the country’s incoming leadership.
China’s economy is slowing down, but a soft landing is still a possibility, thanks to various measures undertaken by the government that are helping to offset economic headwinds from Europe. Just the same, the country is experiencing an abundance of bad news. In September, for example, HSBC and Markit published a purchasing manager’s index that suggests that Chinese manufacturing was in negative territory for the 11th consecutive month. The PMI was 47.9 in September compared to 47.6 in August; a reading below 50.0 indicates a decline in activity. The weakness was largely related to poor export performance. The sub-index for export orders reached its lowest level in 42 months, and the sub-index for employment was also in negative territory.
Exports are the primary culprit. China’s government reported that total exports were up a very modest 2.7 percent in August from a year earlier. Exports to the EU were down 12.7 percent from a year earlier, and Chinese imports fell 2.6 percent in August to their weakest performance since 2009. This was partly due to declining commodity prices, but it also reflected weakening demand in China. Industrial production was up a relatively modest 8.9 percent in August. Automobile sales were up 8.3 percent in August, far slower than the pace of the last few years. All of this news suggests that China’s economy is weaker than expected, and the anticipated rebound is not yet here. It also boosts expectations that the Chinese authorities will engage in further measures to stimulate the economy.
Meanwhile, weakness in the industrial sector is having a negative impact on investment into China. In August, China experienced a net outflow of capital for the third time in 2012. This means that investors are moving money out of China, perhaps as a result of the declining profitability of Chinese companies and pessimism about the Chinese economy. To facilitate the outflow and prevent a drop in the value of the currency, the central bank sold foreign currency. The central bank is boosting domestic credit in order to offset the negative impact on the money supply of sales of foreign currency. When a country experiences a net outflow of capital, it either leads to a decline in the value of the currency or a decline in the money supply if the central bank intervenes to hold the currency steady. Evidently, China’s authorities are averse to allowing currency depreciation as it would likely draw criticism from foreign governments. Given this political climate, China’s central bank has been intervening to keep the currency steady by trying to mitigate rising inflation and declining currency that could kindle political unrest. Yet at the same time, it is assuring that money supply growth continues at a moderate and rising pace.
One effect of the weakening industrial sector is a decline in Chinese company profitability. The profits of China’s industrial companies fell in August for the fifth consecutive month. Profits were down 6.2 percent from a year ago, the fastest rate of decline this year. Corporate revenue continues to increase, but export-oriented companies are struggling to maintain sales by cutting prices, resulting in weaker profitability.
To deal with the slowdown in economic activity, the government has taken a variety of actions. The central bank cut the benchmark interest rate and reduced banks’ required reserves, thereby boosting bank lending. In addition, the government has increased public investment in infrastructure.
The result of these measures has been positive. China’s government announced that new local currency lending increased by $111 billion in August, the biggest August increase on record. This is very likely due to the recent cuts in interest rates and the reduction in banks’ required reserves. Indeed, the broad money supply increased 13.5 percent in August from a year ago. Increased lending is welcome, given that several indicators have lately been disappointing. The question now is whether the government will choose to take further actions aimed at stimulating the economy. With a change of leadership about to take place in Beijing, major decisions may be put on hold until the new leaders have time to assess the situation.