By Jan van Eck, CEO for VanEck Global
China has been a major contributor to global growth, and its economic activity tends to have significant repercussions for the global economy. To understand where the Chinese economy is in its growth cycle, the two charts below are perhaps the only charts one needs.
Chinese Economy Health Check: PMIs
Source: Bloomberg. Data as of January 31, 2020. Data for Caixin Manufacturing PMI was not available prior to December 2016. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
Purchasing managers’ indices (PMIs)1 are a better indicator of the health of the Chinese economy than the gross domestic product (GDP) number, which is politicized and is a composite in any case. The manufacturing and non-manufacturing, or service, PMIs have been separated in order to understand the different sectors of the economy, and the Caixin manufacturing PMI has a larger share of private companies. These days, the manufacturing PMI is the number to watch for cyclicality.
China’s PMIs for January showed no sign of an impact from the coronavirus. A modest decline in the manufacturing PMIs most likely reflected the timing of the Lunar New Year celebrations and was expected. The official services PMI actually strengthened to 54.1 against the consensus expectation of a decline. The official manufacturing new orders and employment PMIs were also stronger. There is, of course, a possibility that the past stimulus is having a stronger impact—especially in the public sector. A more likely explanation is that the numbers were affected by the timing of statistical reporting and will show a bigger drop in February. Authorities seem to be preparing for this eventuality, offering a massive liquidity injection over the weekend.
We believe this is China’s “whatever it takes” moment, and we expect further aggressive policy moves to help the economy to regain its footing.
Understanding the Credit Cycle: Non-SOE Borrowing Costs
Source: UBS. Data as of January 23, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only. Spreads are measured relative to average yield of 1, 3, 5, and 10 year bonds issued by the China Development Bank.
As with any economy, central bank policy is very important in China. In this chart, we can see that interest rates for the private sector fluctuate, whereas the interest rates paid by state-owned enterprises (SOEs) are pretty stable. Therefore, to understand the credit cycle, we point your attention to this private sector, or non-SOE, interest rate. It spiked in 2018, as a result of China’s crackdown on shadow banking2, meaning tougher lending conditions for the private sector. These interest rates began trending down in the winter of 2018 as the “drip stimulus” appeared to take effect.
High funding costs for smaller firms are often cited as a key reason that stifles their growth. It is therefore encouraging that the just announced emergency package includes measures—such as interest rate subsidies and access to lending—aimed specifically at small and privately-owned companies. This is in addition to January’s blanket 50bps reserve requirements cut (to “nudge” larger banks to provide more credit to smaller corporate clients) and the central bank’s decision to re-benchmark outstanding loan rates to Loan Prime Rate (LPR). Looking forward, the secular reduction in funding costs for small and medium-sized enterprises can only come via structural reform and greater transparency, which should make it easier for investors to assess corporate credit risks.
DEFINITIONS AND DISCLOSURES
1Purchasing managers index (PMI) is an economic indicator derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction.
2Shadow banking comprises private credit intermediation occurring outside the formal banking system.
Please note that Van Eck Securities Corporation (an affiliated broker-dealer of Van Eck Associates Corporation) offer investment products that invest in the asset classes discussed in this commentary.
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