China’s slowdown likely to continue

The first is cyclical measures of economic activity. The official Purchasing Managers’ Index (PMI), which covers 3,000 large firms, and HSBC’s PMI, which relies on a sample of 430 small and medium-sized enterprises, both slipped into contraction territory in the past few months and showed minimal improvement in May and June.

Export growth is likely to remain in single digits, while domestic demand drivers such as infrastructure and real estate investment should exhibit continued stability but no acceleration.

Second, there have been numerous signs of excess capacity in some of China’s key industrial sectors, such as steel and solar energy panels. For example, Chinese firms have been selling off surplus steel on foreign markets and cutting orders for raw materials, contributing to a significant fall in world prices of iron ore and coking coal.

In the solar energy space, the global oversupply has led to the bankruptcy of China’s largest firm, and widespread publicity about the extent of subsidies and official support for local companies, problems associated with the inherent corruption in China’s system of provincial government. The response of the central authorities has been to target new areas of investment such as infrastructure, public services and urbanisation, and to encourage private sector investment.

The third source of the slowdown – tighter monetary policy – points to a broader set of problems that China needs to address if it is to achieve a steady growth trajectory in the next few years.

The authorities have been compelled to squeeze the money markets in the past few weeks because unofficial – or ‘shadow banking’ – sources of credit have continued to grow far too rapidly, at 30-40 per cent a year, compared to regulated bank credit growth (13-15 per cent a year).

Underlying the shadow banking problem is the failure to deregulate official bank interest rates and the continued use of administrative measures to manage the monetary system. To enforce some discipline, the People’s Bank of China allowed money market rates to rise sharply in June, coinciding with the sell-off on Wall Street.

However, unless such tightening moves are coupled with serious efforts to deregulate foreign exchange controls, the result is likely to be a surge of unofficial inflows from Chinese companies with funds abroad.

The new premier, Li Keqiang, has announced that he intends to produce a programme for dismantling exchange controls by year end, but this is unlikely to be a big-bang single event. Even so, Chinese leaders have expressed such broad aspirations before without delivering concrete results.

The expectation is for China’s real GDP to slow to 7.6 per cent for the year and consumer price inflation to remain subdued at 2.2 per cent, held back by a firm currency and deflation at the producer price level.

John Greenwood is chief economist at Invesco