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Stagflation risks mount up in China

Recent key economic data out from China has stoked fears of a more pronounced growth slowdown coupled with a continuation pickup in inflationary pressures. A deadly concoction of slower growth and higher prices that tends to lead to a stagflation environment and if entrenched, counter-cyclical fiscal and monetary policies may face challenges to reverse its adverse effects.

Domestic consumption remained lacklustre with growth in retail sales for June slowed to +12.1% year-on-year from +12.4% recorded in May and below consensus of 11.5%; its third consecutive month of decline. The external environment has not managed to offset the weakness seen in domestic economic as easing global demand has led to slow down in export growth for July to +19.3% year-on-year from +32.2% recorded in June and missed estimates of 20.8%. It is the second consecutive month of easing, hence this risk of a peak in export growth has increased after a high seen in December 2020. Also, given the recent resurgence of global covid-19 infection cases in the form of the more transmissible delta variant have led to most nations’ governments to consider re-enacting more stringent lockdowns that will curtail economic activities which in turn may hamper China’s export growth in the coming months.

On the inflationary front, the Chinese government seems have not win the battle to contain rampant increase in factory-gate prices due to higher commodities. Output prices from producers remain elevated despite a stepped up campaign since May to quell the surge in commodities prices by releasing inventories from strategic reservices, policing hoarding and speculation activities as well as a directive to order stated-owned enterprises to limit their exposures to overseas commodities markets. Factory-gate inflation growth as measured by the producer price index surged to +9% year-on-year in July, its seventh consecutive month of increases while consumer inflation seems to be muted, the consumer price index from July recorded a growth of +1% year-on-year, slight decline from June reading of 1.1%. However, core consumer inflation that excludes food and energy has recorded a surge of +1.3% year-on-year in July, the highest increase in 18 months which indicates that producers may have started to pass on the higher cost of production to consumers.

On the capital markets front, China’s State Council has issued a new five-year blueprint that calls for greater regulation of vast parts of the economy after the recent clampdowns on property developers China big tech and online education firms. The new blueprint has mentioned the food and drugs industries that were left out in the previous announcement and given that the recent regulations have taken on a more “nationalistic blend” to address the social ills of capitalism rather than a “best businesses practices approach”. Thus, investors are now bracing for more sweeping regulations or reforms that may hit on all sectors of the China economy where the Chinese authorities seems to be forgoing corporates’ profitability in return for more social equality.

These nationalistic regulations seem to be walking back on the liberalisation of China’s capital markets to foreign funds that has been in steady progress over the past decade. Share prices of China big tech stocks such as Alibaba, Tencent, JD.com and Meituan, the darlings that have powered China’s economic growth in the recent years have taken most of the brunt and  plummeted by close to -40% from its recent February peak. Given that more regulations are expected to be enacted and targeted at more industries, the political risk premium is likely to be increased and in the short-term we may see more negative sentiment in the China stock market which can translate to capital outflows that can indirectly reduce liquidity in the system and crowd out capital investments and domestic consumption.

On the positive side, new credit growth in China has decreased to the slowest rate since February 2020 where financial institutions offered CNY 1.08 trillion of new loans in July, down from CNY 2.1 trillion recorded on June. Thus, China’s central bank PBOC can do more to loosen its purse strings on its targeted monetary policies after a surprise cut to the reserve requirement ratio on banks last month. A further potential easing move can be a cut on its key policy interest rates either on the medium-term lending facility which the one-year rate has been unchanged at 2.95% since April 2020 or the one-year loan prime rate that is currently at 3.85%, unchanged for 15th consecutive months to negate the risk of stagflation. Time is running out.


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