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Emerging Market Viewpoints – February 2019

Wednesday, February 27, 2019

Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team

The last two occasions when the Chinese authorities decided to stimulate their economy, the result was a substantial increase in the prices for most commodities. This was particularly the case in 2009 in wake of the global financial crisis. Although the stimulus in 2015-16 was quite a bit smaller, it also had a very favourable impact on the price of commodities.

In both instances there were also five interest rate cuts in total as well as significant cuts in bank reserve requirements. The latest stimulus by the Chinese authorities has also seen five cuts in reserve requirements, although not one rate cut at the time of this writing.

An even more effective way than monetary policy for China to stimulate its economy are administrative measures and other “arm twisting” by the authorities.

In 2008 credit growth grew by 36%, an extraordinary number given the size of the Chinese economy. At the time it was equivalent to an extra 10% growth in U.S. consumer spending By comparison, credit grew only 17% during the last stimulus in 2015-16.

Last year, credit growth in China was 9.5%, it is this number we need to monitor in order to gauge the true size of any Chinese stimulus. We do not expect to see credit growth anywhere approaching 2009 or even the levels seen in 2015-16.

The main reason for this is that the Chinese economy is now much more leveraged than in the past, with total debt approaching 250% of GDP. This surely limits the amount of additional debt that the government is willing to tolerate. Secondly, China has gone from running significant current account surpluses in the past to a balanced position today. Again, this limits the amount of stimulus the government is able to implement without moving the country into a position of having to finance a current account deficit.

In determining the size and nature of any stimulus it is first necessary to ask why one is needed in the first place. Chinese policymakers are reacting to an extremely sharp slowdown in the “coastal” or export led economy. The country’s export base of factories producing goods for western companies is located in an arc approximately from Shanghai to Shenzhen.

This part of the economy has seen a significant slowdown, with local data indicating that electricity consumption by factories has plunged by 15% from September alone as exporters migrate their factories to other countries, primarily in South East Asia. Samsung for example, pulled more than 70% of its mobile supply chain in China to Vietnam. Local Vietnamese data is confirming this massive movement in supply chains, with Ho Chi Minh province enjoying some 40% export growth year on year.

Obviously, this trade war-induced shock to the economy has seriously imperilled all of Beijing's five-year plan numbers, and officials at every level of the economy from Beijing down to provincial capitals are calling for more stimulus. Whatever development plans that were already in the pipeline seemed to have been accelerated.

The one area that China has a lot of scope to relax is the property sector. Almost all tier one and tier two cities have fairly strictly enforced restrictions on purchases as well as limitations on credit availability for both buyers and developers. China can also accelerate its plans for so called “Garden Cities”. There are at least two in planning stages: Beijing and Chengdu, but observers suggest there may be another three yet to surface.

The Beijing Garden city, for example, is estimated to be $300bn spend over a decade to build a university city, powered by renewables, and hosting a set of technology campuses designed to deliver on the technology ambitions of the current Politburo. (Think: military, space, and most notably a wholesale transformation of vehicle transport from fossil fuels to electric).

As far as we are aware there are no published numbers on the totality of this stimulus effort, but if you look at satellite pictures, you can clearly see a very notable pickup in industrial pollution as the classic trio of steel, cement, and glass factories go into overdrive. This has pushed the iron ore price to new cycle highs, and that is the most obvious external commodity impact at the present time.

IMPORTANT INFORMATION | Issued and approved by Pacific Capital Partners Limited, a limited company registered in England and Wales, authorised and regulated by the Financial Conduct Authority. TThe information contained herein is not approved for use by the public and is only intended for recipients who would be generally classified as investment professionals. Information or opinions contained in this article do not constitute an offer to sell or a solicitation, or offer to buy, any securities or financial instruments or investment advice or any advice or recommendation in respect of such securities or other financial instruments. Where past performance is shown it refers to the past and should not be seen as an indication of future performance.

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