China – The Visible Hand at Work

From a near stall experienced at the end of 2008, Chinese growth has been improving with manufacturing surveys indicate expansion, residential property shows sign of stabilization, consumption has held up – stems from Beijing’s aggressive policy in response to the economic crisis.

Exports may have stabilized at a low level, but imports continue to be weak. Commodities have dominated Chinese imports, as China took advantage of cheaper prices. It may slow its purchases in 2H2009 as commodity prices now climbing and stockpiles filled. So far, commodity exporters have benefited most from the surge in Chinese commodity demand.

Thus far, government investment has driven growth acceleration while domestic private demand has weakened. So far, Chinese electrical demand has yet to match the surge in investment and industrial production.

In an effort to limit unemployment, the government has purchased excess output including metals, grains, and goods to refined fuels to processed metals. Chinese consumption has held up, but from a low base and the strong performance of retail and auto sales, prompted in part by incentives does illustrate the ability of the government to influence public and private consumption. It raises the possibility that China may have had a stronger underlying domestic demand dynamic than many credited.

Chinese bank lending has been particularly aggressive, reaching a value equivalent to 25% of China’s 2008 GDP. But this lending, whose pace reaccelerated in June 2009, might contribute to asset bubbles, especially in property and could increase non-performing loans in the future. Small and medium enterprises, however, still have challenges finding funds. Of late, officials have begun mopping up some of the liquidity through issuance of bills.

Given the still speculative nature of the Chinese markets and the influence of government policies, the equity market could be vulnerable for a correction. It is worth remembering that Chinese markets are buffered form foreign portfolio flows, given investment restrictions, and that the Chinese government is carefully restarting the IPO pipeline.