China's Rate Cut Will Not Bolster Economy
The People's Bank of China (PBoC)'s decision to lower interest rates again (by 25bps to 4.35%) on October 23 will do little to support economic growth and will further undermine confidence in the yuan, which we expect to weaken considerably over the coming months. The rate cut will not be the last, and we maintain that some form of quantitative easing will ultimately be relied upon to prevent a credit crunch and the associated debt-deflation cycle.
Equities will likely benefit, with the H-Shares market still looking attractive following the recent bottom (see '10 Reasons To Turn Bullish On H-Shares', September 8). While the earnings outlook is poor and asset quality will come under serious strains as the economy continues to slow, further monetary stimulus will provide support to asset markets.
Liquidity Provision No Substitute For Structural Reform
Total social financing continues to rise as a share of GDP, and while lower interest rate costs will provide some respite to businesses that have high debt levels, and may encourage a marginal increase in the demand for loans, the Chinese economy is desperately in need of wealth creation as opposed to growth stimulation. Lower interest rates will merely retard the much needed process of economic rebalancing, in which loss-making and indebted businesses, mainly in the heavy industry and materials sectors, must be allowed to scale down operations to give the more productive sectors of the economy a chance to thrive.
There is still little evidence that the government is willing to make this a reality. Despite a few stories of bankruptcies in the steel-producing sector of late, that industry in particular is a prime example of profitless growth coming at the expense of wealth creation. Steel production continues to rise despite a sharp fall in demand and profits, with the result being a surge in exports over recent months. Conditions in the steel industry are echoed in other industries, where industrial profits continue to dwindle in line with the cooling of infrastructure and real estate construction.
The more the PBoC relies on monetary stimulus to prevent a collapse in growth and a financial crisis, the longer it will take to correct the economy's imbalances, and the weaker the long-term growth outlook will become. This was the course of action employed by the Japanese authorities following the 1980s growth boom, and seems to be the path that the Chinese authorities are going down, supporting our long-held bearish views on economic growth.