Market pessimism about the short-term macroeconomic outlook on China is likely to be overdone, says Fitch Ratings.
That said, the consequences of China’s rapid build-up in debt from 2008-2014 still need to be addressed, and market expectations for the economy’s medium-term growth potential may get revised lower. Spillover effects from a more protracted China slowdown could have significant regional and global credit implications.
The 25 August move by the People’s Bank of China (PBOC) to cut interest rates and banks’ reserve requirement ratios (RRR) by 25bp and 50bp, respectively, highlights the authorities’ policy flexibility to support the economy. Monetary easing has been relatively modest despite the marked slowdown in growth thus far in 2015 and persistently weak inflation indicators. The impact on domestic liquidity of easing has been mitigated by capital outflows.
The authorities still retain significant room to loosen policy further, with the one-year benchmark lending rate at 4.6% and RRR for large banks at 18%. Even after yesterday’s cut, the RRR is still only 3.5pp off of its peak. The 4.7% devaluation of the yuan against the US dollar since 10 August has been modest – considering that the yuan had appreciated by almost 20% in trade-weighted terms since 2012.
The government also retains substantial ammunition on the fiscal side. It is important to note that fiscal policy was most probably tightening through the first half of the year, on account of restrictions on local-government financing as part of the broader structural reform process. This is now being partly reversed, and the effects on domestic demand should begin to be felt in the next few months.
Furthermore, demand and output indicators do not point to an exceptionally rapid, disorderly or broad-based deceleration. Consumption and labour market indicators have remained robust, though data have been weaker for exports, investment and manufacturing. August flash PMI data fell to 47.1, according to data released on 20 August, signaling contraction in the industrial sector.
But it is important to highlight that China’s structural economic policy has been to deliberately transition away from investment and exports towards domestic consumption. As such, areas such as manufacturing and construction have been driving the slowdown broadly in keeping with central government objectives.
Over the medium term, however, Fitch continues to highlight the potential for a prolonged period of lower growth, with real GDP expansion settling into a ‘new normal’ likely to be well below 7%. The enormous accumulation of debt following the 2008 global financial crisis, and over-investment in the residential real estate market, still need to be addressed, and will exert a drag on the economy over several years. Fitch’s base case is that there could be about three to four years of excess investment in residential housing that will need to be worked through.