Slowdown In Full Effect

BMI View: Recent data from China, including another disappointing PMI figure, reflect a rapidly slowing economy. While the People's Bank of China (PBoC)'s recent liberalisation of the yuan is an attempt to boost the competitiveness of Chinese exports, the balance of the government's other economic reform initiatives will in our opinion be growth-negative, and we therefore maintain our below consensus real GDP growth forecast of 7.1% for 2014.

China's HSBC/Markit Flash Purchasing Managers' Index (PMI) has disappointed to the downside once again, posting at 48.1 versus consensus expectations of 48.7. The result puts the metric solidly in contractionary territory for the third straight month, and adds to the list of indicators corroborating our expectations for a significant slowdown in the broader economy. February data also showed a rapid deceleration in fixed asset investment, which fell to its slowest rate of expansion (17.9% year-on-year [y-o-y]) in nearly 13 years. Meanwhile, February exports witnessed a massive retrenchment, with externally-bound shipments falling by 18.1% y-o-y in the category's worst showing since August 2008.

Data Painting A Bleak Picture

Further Into The Contractionary Depths
China - HSBC/Markit Flash PMI

BMI View: Recent data from China, including another disappointing PMI figure, reflect a rapidly slowing economy. While the People's Bank of China (PBoC)'s recent liberalisation of the yuan is an attempt to boost the competitiveness of Chinese exports, the balance of the government's other economic reform initiatives will in our opinion be growth-negative, and we therefore maintain our below consensus real GDP growth forecast of 7.1% for 2014.

China's HSBC/Markit Flash Purchasing Managers' Index (PMI) has disappointed to the downside once again, posting at 48.1 versus consensus expectations of 48.7. The result puts the metric solidly in contractionary territory for the third straight month, and adds to the list of indicators corroborating our expectations for a significant slowdown in the broader economy. February data also showed a rapid deceleration in fixed asset investment, which fell to its slowest rate of expansion (17.9% year-on-year [y-o-y]) in nearly 13 years. Meanwhile, February exports witnessed a massive retrenchment, with externally-bound shipments falling by 18.1% y-o-y in the category's worst showing since August 2008.

Further Into The Contractionary Depths
China - HSBC/Markit Flash PMI

Data Painting A Bleak Picture

Given the confluence of such negative data releases, we believe that the writing is on the wall in terms of the economy's overall trajectory. As we have long argued, the Chinese economy is overdue for a period of retrenchment and consolidation following huge credit excesses that saw the country's overall credit-to-GDP ratio soar from approximately 150% in 2009 to over 210% presently. The extreme pace of credit growth (as well as the implementation of numerous fiscal stimulus packages) dating back to the Global Financial Crisis have necessitated ongoing boosts to credit creation in order to simply maintain an orderly slowdown in economic activity. While the Chinese government has managed this feat relatively well thus far by wielding its extensive levers of control over the country's financial system, it now finds itself in an increasingly untenable position.

Years In The Making
China - Fixed Asset Investment (Ex-Rural), % chg y-o-y

One major method by which brisk credit creation has been maintained has been through China's increasingly nebulous shadow-banking system, which masks lending risks by shifting risky lending off of balance sheets. Recognising the rapid run-up in systemic risk that such a system poses to the real economy, the government has vowed to clamp down on shadow lending practices following its seminal Third Plenary Session in November 2013. However, a clampdown on such lending practices will have serious implications on both the pricing of risk as well as the extension of credit in China, and we believe that the current slowdown is an early reflection of this tighter credit environment.

Growth Negative Reforms Put Government In Tough Spot

This process chimes with our ongoing view that the government's economic reform campaign, if successfully implemented, will be largely growth negative. One notable exception to this notion, however, is the People's Bank of China (PBoC)'s recent liberalisation of the Chinese yuan, which has allowed the currency to weaken by 2.9% since its January peak. In our opinion, the PBoC's move is both a reflection that the government and central bank are keen to move forward with economic reforms, but are at the same time looking to boost the competitiveness of the Chinese yuan in order to bolster the export growth outlook. In fact, as reflected by our long-held forecast for the unit to weaken (see chart), the central bank's move was largely in line with our expectations.

PBoC Sending The Yuan Weaker
China - Exchange Rate, CNY/US$ & BMI Forecast Vs. Consensus

Nevertheless, we do not believe that even a more substantive sell-off in the CNY will be sufficient to boost growth over the coming quarters. With Xi Xinping's government intent on hard-hitting economic reforms that will necessitate a tapering of credit growth amid on ongoing slowdown in fixed asset investment, we are therefore happy to maintain our below consensus forecast for real GDP growth of 7.1% in 2014, and expect consensus expectations to move further in our direction as data releases continue to surprise to the downside (see chart below).

Consensus Confounded
China - Citi Economic Surprise Index

Likewise, although we are maintaining our forecast for the Chinese yuan to finish 2014 at CNY6.2000/US$ in light of the fact that the PBoC is unlikely to allow significant volatility in the unit, we note that downside risks to this forecast are nonetheless on the rise.

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