The market was relieved on April 15 when China’s first quarter GDP reading came in as expected at 7.4 percent year-over-year. However, these headline readings have far from bottomed out and economists expect a further slippage in GDP readings to about 6.8-7 percent in the medium-term.
China announced small-scale stimulus measures earlier this month to support its ailing economy. China’s State Council, the government’s executive body, unveiled a package that would include spending on railways, upgraded housing for low-income households and tax relief for struggling new businesses. This package however, is nowhere close to the $650 billion stimulus which was announced in 2009 in the aftermath of the credit crisis in the United States.
Two factors – rising US yields and yuan depreciation, can lead to Beijing officials unleashing a bigger stimulus in the coming months. According to Citigroup, the recent depreciation of the yuan against the dollar and continued QE tapering (which would lead to higher bond yields) in the US will likely prompt the Chinese entities to cover their short FX positions, which is equivalent to a capital outflow.
Although, China’s extensive capital controls would make a rampant capital exodus unlikely, Citigroup estimates net non-FDI capital outflow of around $200bn this year, similar to that of 2012. In this scenario, they expect the USD/CNY spot to rise in the near term but fall to around 6.08 by year-end following a volatile path.
Annual M2 growth, the broadest measure of money supply in China, decelerated sharply from 13.3 percent in February to 12.1 percent in March. This moderation undershot market expectations of a 13 percent increase and represented the lowest rate on record. Citigroup analysts estimate that the People’s Bank of China (PBOC) will need to inject about rmb 1 trillion of liquidity on a net basis for the rest of the year, or cut the Reserve Requirement ratio (RRR) by 50-100 bps to achieve 13-14 percent M2 growth.
The alarming rate of rapid increase in China’s short term debt also increases the possibility of capital outflows in the short term. During 2008-2013, the long- term debt grew by 2.6 percent per year on an average, while short-term debt (maturing in less than one year) increased by 24.5percent annually. In 2013, the increase in external debt ($126 billion) can be completely attributed to short-term debt according to Citigroup. The accumulation of this massive short term debt can be attributed to the carry trade. yhe Yuan appreciation over the past couple of years (prior to 2014) and the interest rate differential between China and the developed western nations encouraged firms to borrow abroad and invest in onshore domestic yuan-denominated assets.
This column has discussed the reasons for China’s attempt to weaken its currency in the short term. The size of the capital account surplus suggests that the yuan is only slightly undervalued at current levels according to Citigroup. Large-scale capital outflows could slow down base money creation and drain liquidity out of an already tightening economy.
Going forward, market participants must keep a close eye out for the price action in US 10-year yields and the directional movement of the yuan against the US dollar. The timing and scale of another Chinese stimulus would be a function of these two factors going forward.
(Vatsal Srivastava is consulting editor for currencies and commodities with IANS. The views expressed are personal. He can be reached at email@example.com)
Published in The Indian Sun/Melbourne’s favourite Indian magazine