China's painful adjustment to sustainable rate of growth

ISI Group: - China’s July exports, imports and trade balance were all weak, mirroring global economic performance and encouraging Beijing to react with stimulus. Any stimulus will be welcome, but far more welcome would be economic conditions that did not require a rescue effort. No wonder Beijing won’t let itscurrency rise against the USD. Together with yesterday’s IVA, FAI and Retail Sales data, China looks weak – except when compared to everywhere else.

Somewhat unprepared for the new reality, China is quickly and involuntarily shifting into more sustainable levels of growth. The double digit growth had become embedded in expectations for jobs creation, property value growth, export expansion, demand for raw materials, etc. Return on investment expectations for retail, institutional, and corporate investors have also fallen into the comforts of double digit returns. But it's time to adjust these expectations. Gone are the days of investing in a new factory and generating 25% or higher IRR. Housing developments no longer provide such returns either. The "easy money" is gone.

Nationally export growth of 1% YoY would not be viewed as a disaster in many nations these days, but it feels like one in China.

China export growth YoY (source: Bloomberg)

An unexpected decline in new domestic loans still follows a reasonable long-term growth path but may also feel like a disaster.

Monthly CNY loans in China  (source: Bloomberg)

And interest rates dropping to new lows, forecasting slower growth, is the global reality that is difficult for many in China to accept.

1y domestic (SHIBOR) interest rate swap (source: Bloomberg)

Unprepared for this reality, domestic industries and markets are once again expecting more government stimulus. Beijing however is not yet ready to revert to heavy infrastructure projects of 2009 (which caused a number of problems), and is trying new creative ways of stimulating domestic demand to compensate for declining exports.

Reuters: - Chinese companies will subsidies purchases of kitchen appliances from Friday in a trial aimed at boosting domestic consumption, an industry body said, the latest step to lift China's economy which is mired in its worst slowdown in three years.

Shoppers buying home appliances including microwave ovens, electric cookers, electric fans and extraction fans will be subsidized by as much as 10 percent of the sales price, the China Household Electrical Appliances Association said.
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The private-sector plan ["encouraged" by the central government] mirrors one run by the government, which has earmarked 26.5 billion yuan ($4.17 billion) in subsidies for energy-saving home appliances.

More of such programs/subsidies will be announced in the near future. They will look similar to"Cash for Clunkers" and "First-Time Homebuyer Credit" in the US - all short-term boosts to growth. The hope is that these programs (combined with looser monetary policy) will transition the country to more sustainable growth rates without major economic disruptions (that may feel like a "hard landing").

The risk to the nation's power structure however is that the Communist leadership will fall under more scritiny going forward. At 12% growth rate people may look the other way, but at half that rate - which would be a dream-come-true for most developed nations - social unrest may become an issue once again.

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