Written by Leland Miller and the staff at China Beige Book
Executive Overview
So far, 2017 has played out as a best-case scenario for China’s economy. The remarkable absence of both domestic (more foolish financial policies) and foreign (Trump tariffs) shocks have created the stable environment corporates need to outperform most expectations, including ours.
This fortuitous run continued for at least one more quarter. China Beige Book’s new Q2 results show an economy that improved again, compared to both last quarter and a year ago, with retail and services each bouncing back from underwhelming Q1 performances. Manufacturing’s rally has now surpassed the one-year mark. Commodities surprised to the upside, despite significant price volatility in April. All this outmatched a slowdown in property and enabled hiring to improve almost across the board.
Three developments are worth extra emphasis. Any worries the leadership had about the labor market prior to the Party Congress have likely evaporated, with hiring improving on an already solid Q1 – both nationally and in all the major sectors. Claims of fading Chinese manufacturing turn out to have been premature, and new orders say at least another quarter of solid expansion is coming. And, while it’s only one quarter, it was all accomplished despite the initial signs of deleveraging – interest rates spiked and borrowing edged down. Facing the challenge of a very poor start to 2016, the Party has turned the economy back in the right direction, with time to spare.
Even in Beijing, though, there is no free lunch. Companies across the economy understand that 2017 needs to be a strong year economically and are storing problems away for the future. Literally – inventories hit their highest levels in the history of CBB data, both nationally and in every sector. The same companies who report solid results on most indicators also continue to show cash flow in the red – corporate health has not yet responded to better growth. And property continues to make investors nervous. As we predicted last quarter, the sector as a whole weakened noticeably despite a major turnaround in residential construction.
The credit market is also a source of heartburn. Firms did not report higher borrowing costs in Q1, but they certainly did so in Q2. Either firms expect the spike to be temporary or they are bearing up under the strain temporarily for political reasons. Either way, China has not yet even begun to face the pain from deleveraging, so the commitment to do so remains very much in question. It remains true that either rates have to come plunging back down, as the NDRC recently called for, or the present level of corporate activity is headed for a cliff. Today’s feast may have been bought with tomorrow’s lunch money. But for now, we toast the solid quarter.
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