China has been a major contributor to global growth, and its economic activity tends to have significant repercussions for the global economy. To understand where the Chinese economy is in its growth cycle, we highlight a few key charts below, which may also provide context for the impact of the coronavirus.
China-related political and geopolitical headlines are grabbing the most attention lately. However, China remains an important economic bellwether for countries that have just started to reopen following the COVID-19 epidemic.
Chinese Economy Health Check: PMIs
Source: Bloomberg. Data as of June 30, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
China’s latest activity gauges clearly show that the policy stimulus is bringing results. Both manufacturing and services Purchasing Managers Indices (PMIs) accelerated in June, exceeding expectations and staying in expansion zone. Even though production still leads the recovery, domestic demand is catching up fast. Importantly, the new orders sub-index rose to 51.4, signaling that the recovery has legs, in our view.
Understanding the Credit Cycle: Non-SOE Borrowing Costs
Source: UBS. Data as of May 28, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only. Spreads are measured relative to average yield of 1, 3, 5, and 10 year bonds issued by the China Development Bank.
As with any economy, central bank policy is very important in China. In this chart, we can see that interest rates for the private sector fluctuate, whereas the interest rates paid by state-owned enterprises (SOEs) are pretty stable. Therefore, to understand the credit cycle, we point your attention to this private sector, or non-SOE, interest rate.
One area where Chinese authorities had been less successful is lowering the funding costs—especially the real ones—for privately owned companies. Corporate spreads for non-state owned enterprises remain stubbornly wide, despite a barrage of policy pledged and initiatives. Note that the small companies PMI stayed in contraction zone in June—unlike the index for large (and presumably state-owned) firms. One can argue that as long as China’s small firms continue to stumble, so will the employment PMI (incidentally also still in contraction zone in June). These numbers call not only for the ongoing targeted support for small and privately owned firms, but for more “out of the box” solutions.
Finally, China’s June PMI show that external headwinds are still here. Although the new export orders contraction looks less severe than in May (42.6), this factor might continue to create bumps on the road to recovery.
DEFINITIONS AND DISCLOSURES
Source for all PMI data: Bloomberg
1Purchasing managers index (PMI) is an economic indicator derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction. We believe PMIs are a better indicator of the health of the Chinese economy than the gross domestic product (GDP) number, which is politicized and is a composite in any case. The manufacturing and non-manufacturing, or service, PMIs have been separated in order to understand the different sectors of the economy. These days, we believe the manufacturing PMI is the number to watch for cyclicality.
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