China remains biggest potential source for an unpleasant surprise for global markets


China’s economy holds up in May but slowing investment points to cooling

By Kevin Yao and Elias Glenn | BEIJING

China’s economy generally remained on solid footing in May, but tighter monetary policy, a cooling housing market and slowing investment reinforced views that it will gradually lose momentum in coming months.

Still, with half a year left to go, Beijing is expected to handily meet its annual 6.5 percent economic growth target without too many bumps, good news for President Xi Jinping ahead of a major political leadership reshuffle later this year.

China’s fast start to the year led the International Monetary Fund on Wednesday to raise its 2017 growth outlook for the country to 6.7 percent from its 6.6 percent forecast in April, though it recommended China accelerate reforms and rein in credit.

Credit and money supply data on Wednesday showed China may be making progress in the battle against risky lending and rising leverage as May bank loans topped expectations but money supply grew at the slowest annual rate in over 20 years, which the central bank attributed to deleveraging.

Off-balance sheet lending, or shadow banking activity, also fell sharply in May after rising earlier in the year.

But the People’s Bank of China (PBOC) said it will balance deleveraging with the need to keep liquidity basically stable, adding that slower money supply expansion could be a “new normal”.

Slower fixed asset investment growth in May and a sharp deceleration in housing starts seen in data on Wednesday point to some of the cooling economists have been expecting, though stable growth in factory output and retail sales, along with a pickup in exports, are cushioning the impact so far.

But a rise in inventories in the industrial sector and weaker producer price inflation will drag on growth ahead, said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong.

“The first half of this year was a very happy period for China in the sense that we had that wonderful increase in output prices,” said Kuijs, referring in part to a construction boom which boosted demand and profits of structurally unhealthy sectors such as steel.

After rolling out a slew of measures early in 2017 ranging from short-term interest rate increases to a clampdown on riskier forms of lending and shadow banking, authorities have appeared to pause in recent weeks as the government looks to ensure political and financial market stability before a Communist Party Congress in autumn.

With slower nominal growth going into next year, “the willingness to tighten significantly (further) on the monetary side will be pretty low”, Kuijs said.


Industrial output grew at a steady 6.5 percent pace in May from a year earlier, defying expectations for a slight softening, as a government infrastructure spree continues to boost demand for building materials from cement to steel.

But rising inventories are a risk. In April, growth in industrial inventories picked up to over 10 percent.

Weaker growth in fixed asset investment — at 8.6 percent for January through May — was led by a slowdown in the property sector.

While housing sales rose by an unexpectedly solid 10 percent, growth in new construction starts almost halved to 5.2 percent in May, according to Reuters calculations.

Analysts expect the housing market to continue to slow, as the government remains wary of still-rising home prices and has maintained strict controls on home purchases and property financing.

Infrastructure spending, a key lever for the government to stabilize growth in the face of any slowdown, slowed to 20.9 percent growth over the first five months of the year.

Growth of private investment slowed slightly to 6.8 percent in January-May, suggesting a slight weakening of the private sector’s appetite to invest as small- and medium-sized private firms still face challenges in accessing financing and now rising funding costs.

Retail spending was more upbeat, rising 10.7 percent from a year earlier, unchanged from April and beating analysts’ expectations for a decline despite the first back-to-back drop in auto sales since 2015.


Economists at Nomura forecast China’s economy will grow an annual 6.8 percent in the second quarter, only marginally less than the 6.9 percent in the first quarter and providing enough momentum to coast to the government’s full-year target even if there is some second-half softening.

Fund managers surveyed by BofA Merrill Lynch said China’s credit tightening ranked as the top tail risk for financial markets for the second month in a row in June, with nearly two-thirds of respondents saying it will slow Chinese business activity but have little impact on global growth.

Sources told Reuters on Wednesday that China’s central bank was checking with lenders in Shanghai to see if tighter rules were having an impact on lending or credit quality. Funding costs are rising slowly and banks have been raising mortgage rates.

Still, many analysts say concerns over tighter policy are overblown as measures so far this year have been on the edges and only target financial speculation, not activity in the real economy.

Despite some tightening, “broader liquidity conditions such as M2 growth, loan growth or the growth of outstanding financing are still largely stable,” said Nomura chief China economist Yang Zhao.

“Further tightening should be very limited. I don’t see the People’s Bank of China (PBOC) easing liquidity or monetary policy anytime soon, but the PBOC probably would not further tighten.”

(Reporting by Kevin Yao and Lusha Zhang; Writing by Elias Glenn; Editing by Kim Coghill and Richard Borsuk)


BEIJING — While investors have been preoccupied with President Trump and chaos in Washington, nerve-rattling elections in Europe and the uncertainty created by Federal Reserve policy and Britain’s decision to leave the European Union, a once-familiar — and possibly bigger — risk to global markets has been bubbling in the background.


Two years after China first set off investor alarm bells worldwide with a stock market crash, a slumping currency and concerns over rising debt, many investors have put those concerns out of mind. Shares of Chinese companies traded in Hong Kong and other places outside the mainland have surged to their highest levels since the crash, beating markets in other developing countries, as investors embrace China’s thriving technology and consumer scenes.

Even in China, where the long-downtrodden domestic stock market still suffers from investor skepticism and government meddling, local shares enjoyed a run-up for much of this year before falling back recently.

“The vast majority of consensus opinion is that China is fine,” said Kevin Smith, the founder and chief executive of Crescat Capital, an asset management firm based in Denver that is betting against Chinese investments. Referring broadly to China’s debt and other financials, he added: “People are really not looking at the potential bubble. The bubble just keeps getting bigger.”

 China’s fate has major sway over global markets, given its longtime role as a growth driver — and investors may soon have a bigger stake in the ups and downs of Chinese stocks.

MSCI, an investment advisory firm that compiles stock indexes that are widely tracked by mutual funds and pension funds around the world, is considering adding domestic Chinese stocks to a key benchmark. The company is scheduled to unveil its decision on Tuesday.

Investors have already received some encouragement to jump in. In March, Goldman Sachs recommended investors increase their holdings of Chinese stocks, citing improved economic growth, stable policies and other positives.

But some investors have started to worry again. In a survey released by Bank of America-Merrill Lynch, fund managers in May named China the biggest potential source for an unpleasant surprise for global markets for the first time since January 2016. The investor services firm Moody’s also downgraded China’s sovereign credit rating last month, its first such move in 28 years.

Debt is a central theme to these rising concerns. To shore up its economy, China resorted to pumping up credit, adding to an already mountainous pile of debt. According to the Bank for International Settlements, that debt reached 257 percent of its gross domestic product at the end of 2016, slightly above the same measure in the United States, and significantly higher than the 184 percent for emerging economies over all.

But what worries economists most is the pace at which it has mounted. At the end of 2007, China’s debt stood at only 152 percent of G.D.P.

The research company Capital Economics, in a June report, warned that debt in China “has risen far faster than in almost any other major economy on record,” and that its continued buildup was the “biggest risk facing emerging Asia.”

Over the last several months, the government has tried to reverse this trend, helping slow credit growth. But that, too, has rattled financial markets in China. The fear is that tighter credit could both slow growth and make it more difficult for highly indebted firms to pay back those loans. In a sign of strain, the interest rates charged by banks when lending to one another have been rising.

Following stock market information at a brokerage house in Beijing. Credit Kim Kyung Hoon/Reuters

Policy makers in China appear more worried, too. In late May, the government indicated it would tighten its grip on the renminbi, stepping back from a longstanding commitment to allow market forces a greater role in its valuation.

Mr. Smith of Crescat said he believed global investors remained too complacent about the China threat. Calling China “the largest macro bubble in our lifetime,” he said the situation had “already gone beyond what global financial watchdogs claim are levels where other countries historically have gotten into trouble.”

Mr. Smith has arranged his portfolio with these fears in mind. He said he was shorting China equity funds. (When investors short, they are making financial bets that the price of something is going to fall.) And though such positions have subtracted from his returns so far this year, he has doubled down.



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