by Michael Pettis
Two weeks ago on Wednesday night, after the Chinese markets closed, the People’s Bank of China announced that it had cut the minimum reserve requirement by 50 basis points to 21% for the large banks, and lower for the smaller banks. With the announcement coming just hours before announcements by the Fed, the ECB and the central banks of the UK, Switzerland, Japan and Canada, that they would jointly lower interest rates on dollar liquidity swaps to make it cheaper for banks around the world to trade in dollars, it seemed like world’s major central banks were determined to stimulate global credit growth.
But the PBoC move is qualitatively different from that of the others. I think it is important to remember that changes in the minimum reserve requirements in China have more to do with managing the changes in underlying liquidity caused by net inflows and outflows to China than they have to do with changes in credit. At any rate here is the Xinhua article on the subject:
The People’s Bank of China, the country’s central bank, said on Wednesday that it will lower banks’ reserve requirement ratio (RRR) by 50 basis points for the first time in three years in order to replenish liquidity in the country’s banking system as inflation eases.
The latest cut, effective on Dec. 5, drops the RRR to 21 percent for large commercial banks and 17.5 percent for mid- and small-sized banks. An estimated 396 billion yuan (62.38 billion U.S. dollars) in capital will be released into the market. The move signals that the government is set to stabilize economic growth after easing inflationary pressures, although it is not yet known if the change will bring about a full-on move toward a looser monetary policy, analysts said.
I don’t think anyone was especially surprised by the direction of this move, although the timing was more aggressive than most expected. It has been clear for a while now that China’s economy was slowing and we were pretty much expecting that Beijing was going to take action to spur credit expansion – which is really the only tool Beijing has to manage growth.
But the change in the reserve requirement usually has very little to do with credit growth, except possibly as a way for Beijing to signal its intentions. For the past several years the main role of the reserve requirement hikes has been to soak up liquidity created by the monetization of the increases in the PBoC reserves (and, I suspect, to lower the funding cost for the PBoC, which would otherwise almost certainly run a negative carry). When Beijing wants to affect credit expansion it does so mainly by administratively tightening or relaxing constraints on credit growth.
Since central bank reserves have not risen in recent months – in large part, it seems, because net speculative inflows have reversed (almost certainly because expectations of a stronger RMB have receded) – the PBoC may have decided that it needed to provide liquidity to the interbank market. I suspect that this cut indicates that there were continued net outflows in November, perhaps even substantial. We’ll know soon enough.
In fact the RMB continues to trade sharply down during intraday trading, only to be nudged up overnight by the PBoC fixing. Three weeks ago in my newsletter I wrote extensively about this process and how it is probably a very good indicator of sentiment about RMB appreciation prospects. From the data it seems that speculative capital is leaving China.
The combination of net outflows of flight capital and the sharp reduction in year-on-year inflation in October has left the PBoC feeling that they can afford to relax on the monetary side – even though, as I have long argued, inflation was bound to decline, but not because of traditional monetary tightening.
Growth is slowing
The more interesting question for most of us I think is whether in response to slowing growth Beijing will relax credit constraints in the near term. Everyone who follows China closely knows about problems in the real estate sector, whose importance to growth in China should not be underestimated, but the growth weakness was across the board. An article in last week’s Caixin lists the bad PMI numbers for October:
China’s manufacturing industry contracted, following a brief rebound in October, as the Purchasing Managers’ Index (PMI) dropped below the neutral level of 50 where it neither expands nor contracts, hitting a 32-month low in November.
China’s PMI index for November was 48, down from last month’s 51 due to significant output contractions. According to data released by HSBC and Markit on November 23, this was the largest single-month drop since March 2009.
The output sub-indicator of PMI was 46.7, compared with 51.4 in October. The number of new product orders decreased while the growth for export orders accelerated compared with the previous month.
We were expecting the official PMI numbers to come out Thursday, and the reduction in the reserve requirement Wednesday immediately set off a flurry of emails among the members and alumni of my central bank seminar suggesting that the official numbers were going to look bad too. They were right. Here is an article from the People’s Daily:
China’s manufacturing activities shrank for the first time in almost three years last month under dismal external demand, rising production costs and tight domestic liquidity for small firms.
The official Purchasing Managers’ Index, a comprehensive gauge of manufacturing activities across country slipped from October’s 50.4 to 49 in November, the lowest since March 2009.
A reading below 50 indicates a contraction in industrial activities. The drop was led by declines in new orders and new export orders, both of which scaled back more than 2 points and fell below 50, the China federation of Logistics and Purchasing, the index compiler, said today in a note.
Also, most producers of raw materials and downstream products reported contracting activities, while manufacturers of consumer goods said their operational conditions still improved.
The numbers in the PMI report really aren’t good. Every one of the important indicators are down, and I notice that my friend Mark Williams at Capital Economics is suggesting that year-on-year annualized growth in for the three months ending in October is barely above 7%. He may be right.
Aside from the fact that it will probably take several months before any current change in credit policy will affect growth rates, I suspect that what really worries policymakers in Beijing is the speed with which Europe seems to be collapsing. For two or three years I have been assuring my very skeptical Chinese friends that the problems in Europe were pretty substantial and would be extremely difficult to resolve, but I don’t think they really believed that it could degenerate like this. The past two months, it seems, have been a real shock for Beijing and have forced some pretty rapid reconsideration of external conditions.
Exports are suffering
The impact of the European crisis is shown in the rapid contraction in shipping prices. According to an article in Bloomberg.
The cost of hauling goods to Europe from China is falling faster than rates for deliveries to the U.S. The price for shipments to Europe is down 39 percent to $511 per twenty-foot box since Aug. 31, according to figures from Clarkson Securities Ltd., a unit of the world’s largest shipbroker. That’s more than double the 18 percent slide in the cost to the U.S. West Coast, measured in 40-foot units.
“European imports from China will be much, much lower going forward,” said Rahul Kapoor, a Singapore-based analyst at Platou Markets. “If you see falling freight rates, that would imply that European demand is falling off a cliff.”
…While shipping rates were affected earlier this year by an expansion of the fleet that plies the Europe-China route, stable capacity since August shows the latest drop is a result of weak demand, Kapoor said in an interview today. U.S. deliveries are faring better than those to Europe, he said.
Earlier in the week Xinhua reported the results of a very gloomy survey among Chinese exporters:
A majority of Chinese exporters saw shipments to Europe decline in the past few months as the eurozone sovereign debt crisis weighed on external demand, according to newly released survey data. About two thirds of nearly 600 companies surveyed from Nov. 4 to Nov. 7 said their exports to Europe had dropped in the last few months, with 35 percent reporting significant falls, said Global Sources, a trade information provider, in a statement.
It said 22 percent of the firms reported exports remained stable and 12 percent reported growth in shipments. Nearly 40 percent of the companies surveyed expected further decreases in exports to Europe in 2012, while 29 percent anticipated more shipments, said the statement.
To counter the impact, Chinese exporters said they would accelerate rolling out new products, cut costs and invest more in research and development to improve product quality, according to the survey. Meanwhile, 42 percent of enterprises planned to strengthen their presence in emerging markets including Latin America, the Middle East, Africa, East Europe and the Asia Pacific.
I don’t think there is a whole lot to say about this week’s numbers beyond what I have been saying for the past several months. Nothing substantial has really changed. China’s external account is worsening, and will continue to worsen since global imbalances have no choice but to adjust. Growth in China is slowing but remains relatively rapid, and as unhealthy as ever, but there is little likely to be done to improve the quality of growth until 2013. Beijing will continue veering back and forth between stomping on the credit accelerator and stomping on the credit brakes as the only way they can manage the economy.