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Is Chinese Stimulus a Sign of Weakness?

Sheraz Mian

Thursday, April 3, 2014

A stimulus package out of China and monetary policy action (or inaction rather) from the ECB provide the backdrop for today’s trading action. Stocks have been making new all-time highs in recent days on largely in-line economic data. Today’s Chinese announcement could help sustain that momentum, but it wouldn’t be unusual for the market to take a pause in today’s session ahead of Friday’s all-important jobs data.

The service sector ISM survey will be coming out a little later and this morning’s Jobless Claims and Trade Deficit data is largely in-line with the recent improving tone of economic data. We will know more tomorrow after the March jobs report, but the overall take-away from this week’s March data is that the U.S. economy has started to thaw from the Winter freeze it had fallen into, though the magnitude and pace of the improvement is a tad bit on the low side.

This improving U.S. economic picture aside, the notable news of the day is out of China, with announcement of plans to increase spending on railways, low-income housing and tax relief for small businesses. Details about the total size of the package and whether it will have a monetary component are unclear at this stage, but we know very well why they felt the need to go this route.

Chinese economic data in the first quarter is pointing to GDP growth falling short of the government’s 7.5% target. Questions about China’s growth outlook have been around for more than a year now (remember the soft vs. hard-landing debate). But the picture appeared to be stabilizing in the second half of last year, only to lose steam all over again at the start of 2014. State sponsored spending has been at the core of the country’s growth model and markets had started pricing in some sort of stimulus from the government in response to the recent run of soft data.

The new stimulus package is most likely a fraction of the 2009 version that kept the country’s economy humming even as the global economy suffered as a result of the financial crisis. But many of the bad loans hobbling the financial sector at present, the extent of which is unknown to anybody, were initiated in those heady times. The projects completed then, mostly in infrastructure and real estate developments, are unable to service the loans taken from state banks to fund them. Facts are hard to come by in China’s opaque financial system, but a big part of recent bank lending activity has been to roll-over those problematic loans. We don’t know whether the new package will be accompanied by renewed bank lending or not, but the country’s financial sector is a lot weaker now than was the case five years ago.

Markets will likely cheer the new package. But instead of being a sign of the Chinese economy’s resilience and strength, it’s a sign of its weakness, vulnerabilities and over-reliance on state support.

Sheraz Mian
Director of Research

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