Our Take On The Latest Stimulus

BMI View: The prevailing negativity surrounding China's near-term macro prospects has been softened somewhat by news of yet another 'mini-stimulus' unveiled by Beijing. As has been the case in the past, our view is that further fiscal and monetary pump priming will fail to arrest the structural deceleration in the Chinese economy and will, at best, merely serve to cushion the slowdown. That said, an unwinding of downbeat sentiment bodes well for a continuation of relief rallies in Chinese equities and risk assets at large. We remain tactically bullish towards the Shanghai Composite and Chile's benchmark IPSA index.

In recent weeks, the prevailing negativity surrounding China's near-term macro prospects has been softened somewhat by news of yet another 'mini-stimulus' unveiled by Beijing. While facts and figures are thin on the ground, the total slew of measures is expected to total around CNY500bn (US$81.7bn) and will be centred around a ramp-up in railway investment, temporary tax cuts for small and medium sized enterprises (SMEs), and an extension of credit to local governments.

In this article, we look at the likely growth impact of such measures and, at the risk of repeating ourselves, argue why yet another round of stimulus will fail to arrest the structural deceleration in the Chinese economy.

Less Bang For Buck
China - Manufacturing Purchasing Managers Index

Our Take On The Latest Stimulus

BMI View: The prevailing negativity surrounding China's near-term macro prospects has been softened somewhat by news of yet another 'mini-stimulus' unveiled by Beijing. As has been the case in the past, our view is that further fiscal and monetary pump priming will fail to arrest the structural deceleration in the Chinese economy and will, at best, merely serve to cushion the slowdown. That said, an unwinding of downbeat sentiment bodes well for a continuation of relief rallies in Chinese equities and risk assets at large. We remain tactically bullish towards the Shanghai Composite and Chile's benchmark IPSA index.

In recent weeks, the prevailing negativity surrounding China's near-term macro prospects has been softened somewhat by news of yet another 'mini-stimulus' unveiled by Beijing. While facts and figures are thin on the ground, the total slew of measures is expected to total around CNY500bn (US$81.7bn) and will be centred around a ramp-up in railway investment, temporary tax cuts for small and medium sized enterprises (SMEs), and an extension of credit to local governments.

In this article, we look at the likely growth impact of such measures and, at the risk of repeating ourselves, argue why yet another round of stimulus will fail to arrest the structural deceleration in the Chinese economy.

Diminishing Returns Of Stimulus: We have written on several occasions as to why further rounds of stimulus will deliver diminishing marginal returns ( see ' New Liquidity Surge Supports Core Views', February 13 2013). In a nutshell, the base effects of expenditure dictate that a new credit injection would have to be larger than the previous one to generate an additional unit of nominal GDP. In China, this is clearly not the case. The accompanying chart shows the impact of three of major stimulus packages on manufacturing activity. With each passing installment, the scale of stimulus has fallen and clearly so too has the magnitude and duration of the rebound in activity. This time around, the CNY500bn that has been mooted would represent a paltry 0.9% of GDP, a far cry from the 12.5% of GDP package unleashed during 2008-09. Simply put, this is not a game changer for the broader growth story.

Less Bang For Buck
China - Manufacturing Purchasing Managers Index

Can't Cure Solvency With Liquidity: Despite the slowdown seen in China's economy, credit aggregates up until recently had been expanding at a strong clip. Our estimates show that the stock of total social financing (TSF, the broadest measure of the country's money supply) grew by a brisk 24.1% year-on-year (y-o-y) in the first seven months of the year. That the economy is still suffering tells us that the growth malaise is more about the deep-rooted balance sheet problems of Chinese corporates, rather than a lack of available credit.

Solvency Risks
China - Local Government Debt, % of GDP

To be sure, we have seen a series of flagship companies, such as solar panel manufacturer Suntech Power Holdings and shipbuilder Rongsheng Heavy Industries, run into severe financial distress in recent months due to massive overcapacity in China's high order industries. Such structural solvency concerns will not be cured with further stimulus. We note that much of the funding has been earmarked for local governments, which have seen their liabilities escalate in recent years ( see chart). We believe that this additional financing is unlikely to be channelled into new capital spending, but instead will be used to roll over existing obligations, meaning that the net impact on economic activity will be negligible.

Waning Appetite For Stimulus: From a political perspective, recent actions by China's fledgling government point to a waning appetite for constant pump-priming ( see 'Reform Momentum Bittersweet For Growth Outlook', April 2 2013). There appears to be a broad consensus in the upper echelons of China's leadership that the huge stimulus packages of the past, while positive for near-term growth, have exacerbated the fundamental problems facing the economy. While some policy loosening was to be expected given that the economy has lost considerable momentum and credit concerns have come to the fore, we believe Beijing will be unwilling to stomach a major intensification of stimulus measures, not least because such a scenario would further undermine longer-term efforts to rebalance the economy away from investment.

Financial Market Implications

Despite recent announcements, we remain comfortable with our growth assumptions of 7.5% and 6.7% in 2013 and 2014, respectively. However, a further unwinding of downbeat sentiment does bode well for a continuation of relief rallies in Chinese equities and risk assets at large. Sentiment towards Chinese stocks, in particular, remains extremely depressed, with much of the bad news already priced into the market. Strikingly, while few would contend that China's long-term growth outlook is worse than that of Spain, the H-Shares Index is actually trading at a discount to the Spanish IBEX on a trailing price-to-book basis for the first time since mid-2008, from a premium in excess of three times in 2007.

PIIGS Or Dragon?
H-Shares Index & Spanish IBEX, P/B Ratio

We remain tactically bullish China's Shanghai Composite Index, a view we have been playing against India's Sensex since July 2. This view is currently up 7.1% and we see scope for further gains in the near term.

Relief Rallies In Play
China's Shanghai Composite Index (LHS) & Chile's IPSA Index (RHS)

We also see scope for a corrective bounce in a number of global China plays. The Australian dollar, for one, could looks well-placed for a technical bounce given that speculative positioning on the currency is at all-time lows. Meanwhile, our Latin America team has turned constructive towards Chile's country's benchmark IPSA equity index. Not only is the bourse exhibiting bullish divergence technically, but it is also likely to benefit from a bounce in copper as sentiment towards China's demand prospects perks up.

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