China’s sizzlingly (disappointing) growth record

It’s a small indication of the enormous expectations of China these days that Thursday’s announcement of Chinese GDP — 9.6 per cent growth in the third quarter — managed to fuel investor jitters and weigh on some Asian stock markets.

As the FT describes it, China’s growth is “a scorching pace by most countries’ standards but a moderate deceleration in growth from earlier in the year for Beijing”.

The report continues:

A gradual easing in growth is exactly what Beijing has been trying to engineer, and analysts said the 9.6 per cent year-on-year expansion in gross domestic product would please policymakers following increases of 10.3 per cent in the second quarter and 11.9 per cent in the first.

More worrying for the government will be the consumer price index, which showed inflation hitting a two-year high of 3.6 per cent in September. That was only slightly higher than August’s 3.5 per cent. Price rises were mostly confined to volatile food items.

The statistics bureau showed that industrial output meanwhile rose a less-than-estimated 13.3 per cent in September from a year earlier compared with 13.9 per cent in August, reports Bloomberg. September’s inflation rate was driven up by food prices and residential costs such as rent. In August, prices rose 3.5 percent.

Whether a good thing or bad, the effect of the GDP figures, coming after Tuesday’s surprise announcement by China’s central bank of an interest rate rise of 0.25 percentage points , was enough to drive down Chinese stocks and boost the renminbi.

In Japan, the news led to selling in some machinery and commodity names such as Komatsu that export to China, and drove down the steel sector by 1.5 per cent.

London-based Capital Economics noted that, while the data did not show the upsurge in inflation that was widely seen to be behind this week’s interest rate hikes, the rate moves “may have been driven, at least in part, by a desire to raise the cost of capital so that the share of national income going to workers increases. In time, this should support rebalancing”.

China commentator Arthur Kroeber of Dragonomics Advisory, which is part of Hong Kong-based research house Gavekal, meanwhile predicted a further cooling off of economic growth, as he hailed the end of Chinese premier Wen Jiabao’s so-called “put option” in a client newsletter on Thursday:

For the last two months we have unkindly compared Chinese premier Wen Jiabao to the later Alan Greenspan, who helped inflate the US housing policy with his ultra-low interest rate policy which financial markets dubbed “the Greenspan put.” Premier Wen’s put option was his government’s implicit guarantee that GDP growth would never be permitted to fall below 8%. This guarantee destroyed the credibility of all government commitments to structural reform (whose cost is likely to be lower growth), and stoked fears that Beijing simply wanted to buy short-term growth through an endless expansion of credit, and was oblivious to the risk of asset bubbles in the short term and a structurally dysfunctional Japan-style economy in the long term.

We believe that the official and unofficial statements emanating from last weekend’s annual Communist Party plenary meeting ended the Wen Jiabao put option and signaled that structural reformers are in the saddle (although not with unbridled power). Tuesday night’s surprise interest rate hike, coming immediately after the meeting’s close, strongly amplified this signal. While we do not expect dramatic policy shifts, we do anticipate that the pace of reform measures will visibly accelerate over the next 6-12 months, and that the pace of GDP growth will gradually slow from the current 9% clip to a more sustainable rate of 7-8% over the next two years.

As for China’s much-vilified currency — or rather, currency policies — currency strategist Marc Chandler, writing on Credit Writedowns, picks up on what he suggests is Beijing’s cultivation of a market for the yuan — or renminbi — and renminbi-denominated bonds in Hong Kong. He notes:

One of the surprises of the year has been the increased internationalization of the yuan, even though the capital account has not been liberated and the currency remains tightly managed.

We were skeptical of the significance of the yuan swap lines with other countries, primarily emerging markets. However, more impressive has been the growth of a yuan market in Hong Kong. It is a bit confusing in the sense that Hong Kong is a part of China (special administrative region) and of course HK has its own currency (pegged to the dollar). However, the HK financial market is regarded by investors, and treated by Chinese officials, as offshore.

Yuan deposits in HK have more than doubled this year and were near CNY130 bln at the end of August. Yuan trading in Hong Kong has also increased recently. For various reasons, largely regulatory in nature, the demand for yuan in Hong Kong appears quite strong and this is reflected in the yuan trading in HK at a premium to the mainland and that spread has grown in recently.

Part of this demand for yuan appears to be emanating from bond investors. The logic is that international investors quota for onshore investments has been used primarily for buying Chinese equities. This has forced fixed income managers to look for yuan-denominated bonds offshore.

China seems committed to developing this “offshore” market and it’s reasonable, in Chandler’s view, “to expect the HK market for yuan, and yuan-denominated bonds to continue to broaden and deepen”.

Meanwhile, following the New York Times’ report on Wednesday that China is quietly halting shipments of rare earth minerals to the US and Europe, after doing the same to Japan, Bloomberg columnist William Pesek had this to say:

The news trumped China’s surprise decision to raise interest rates this week. It’s a sign that economic cooperation is becoming a quaint concept as China’s clout increases. It’s also the latest reminder that anyone betting on a Plaza Accord- like currency deal next month is dreaming.

Related links:
China rate move turns focus on rising prices – FT
China rate rise suggests economic confidence - BeyondBrics
Paul Krugman – Rare and foolish – NYT
That China rate rise [updated] - FT Alphaville

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