iStock_000005925067Small

Following from a volatile January markets have continued to rally upon a positive US and local reporting season even with continued reduction in US monthly stimulus, mixed economic data, and some negative local news regarding the car manufacturing sector in Australia and notable companies such as Qantas.

Investors are understandably confused and concerned about the trajectory of stock prices with many markets approaching and moving beyond ‘fair-value’ and entering the ‘over-valued’ range. If these returns are expected to continue over the course of the year the state of the Chinese economy is one of the most important factors we need to carefully watch.

However, as is usually the case there are always two sides to any China economic story….

 

So what’s happening in China?

In a previous post we discussed the plan the Chinese Government has mapped out to boost internal consumption and reduce China’s reliance on exports. In doing so Premier Li Keqiang is trying to maintain growth of the Chinese economy above a 7% baseline while reducing the growth of debt and increasing employment.

The challenge Premier Li has in achieving these targets is that Chinese manufacturing activity has slowed over the last month. The Purchasing Mangers’ Index figure has been above the figure that indicates growth of manufacturing, however, the February result was just above this benchmark and has been falling over recent months.

Bloomoberg reports that this slowdown in manufacturing activity is due to the Government’s stance in curbing the growth of debt (or credit) which is reducing the investment in infrastructure and real-estate development. However, commentators such as Louis Kuijs, chief China economist at Royal Bank of Scotland Plc in Hong Kong, say that this 7% growth target can be maintained amidst a slowdown in manufacturing activity as the Government has the ability to introduce pro-growth policy settings such as maintaining low interest rates.

 

Positive or Negative?

Although these pro-growth policy setting would push back the reforms the Chinese Government has targeted to transform the economy to a more sustainable economy not as reliant on the rest on the rest of the world, there are signs that these reforms have already had an effect.

Bloomberg reports that Chinese economic growth will slow to 7.5% this year down from 7.7% in 2013 and highlights that this is the lowest growth rate since 1990. Clearly the Governments work to reduce the growth of debt funding, curb overcapacity that could lead to inflation, and shift from an economy dependant on the rest of the world buying Chinese products to one where the Chinese consumer is king are working. And although these policies are slowing Chinese growth economic commentators believe these transformations are required to protect the Chinese economy from global shocks.

This is supported by news from BlueScope Steel, Australia’s biggest steelmaker, that demand for industrial buildings and construction products in China is falling as steel shipments from BlueScope fell 7 percent in China in the six months to December compared to the previous year as reported by Bloomberg.

 

So yet again there are two sides to this story with initial concern that a slowdown in Chinese manufacturing is pointing to a reduction in economic growth for the world’s second largest economy, while on the flip side this slowdown is a direct result of the Government’s efforts to transform the economy to a more stable and self-sufficient China.