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China Flinches

“Chinese officials have their work cut out for them. Not only are they trying to transform their export-led economy into one driven by domestic consumption and private investment, they’re trying to do so at a time when the global economy is sluggish. That’s proving to be challenging, especially since the performance of China’s own economy has been subpar. It’s also tricky because the country’s desire to move away from growth driven by public investment means it would be counterproductive to prop up the economy with the kind of heavy-handed fiscal and monetary policy that worked rather well during the global financial crisis in 2009,” writes Jens Erik Gould, The Financialist. As a result, China had implemented only moderate stimulus measures this year, such as investment in selected public works projects and new credit lines to certain financial institutions. Broader policy actions such as rate cuts had been off the table. Until recently.

On November 21, China’s central bank revealed the extent of its concern about the slowing economy when it unexpectedly cut its benchmark interest rate for the first time since July 2012, lowering it 40 basis points to 5.6 percent, in addition to cutting the 1-year deposit rate by 25 basis points to 2.75 percent. The move represented a clear shift in policy, say Credit Suisse analysts Dong Tao and Weishen Deng, from “neutral with a slight easing bias” to full-out “easing.”

That shift comes on the heels of news that China’s GDP grew 7.3 percent in the third quarter, the lowest level since 2009, and the fact that the country is on course to miss its 7.5 percent growth target for the year. More recent October data shows persistent weakness. Industrial production rose a lower-than-expected 7.7 percent in October, down from 8 percent the previous month, while retail sales slowed to 11.5 percent from 11.6 percent. And bank credit increased by 548 billion Yuan during the month, well short of a Bloomberg consensus of 626 billion Yuan. “These weak credit data support our argument that risk appetite is low in the banking sector, despite the central bank’s ongoing efforts to provide liquidity,” Tao wrote in a November 24 note.

Meanwhile, foreign direct investment in the first 10 months of the year declined 1.2 percent from last year’s levels, and China’s outbound investment will exceed FDI in 2014 for the first time since the open door policy took hold in the early 80s. “China’s role as the world factory is vanishing as direct investment in the manufacturing sector is shrinking,” says Tao.

Credit Suisse forecasts further slowing, estimating GDP growth of only 6.8 percent for 2015. Tao and Deng also think that last week’s rate cut was just the first in a likely series of easing moves, and expect cuts to reserve requirement ratios over the next six months. With Europe and Japan already easing, China has joined a growing club of central banks that are adopting more accommodative monetary stances, leaving the U.S. as the sole major economic power moving in the other direction.

Editor’s Note: From The Financialist – Presented by Credit Suisse. Photo of China’s central bank by Gang Liu / Shutterstock.com.

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