Bad economic news continues to flow out of China, with the GDP growth rate falling to 24-year low in 2014, credit crunch concerns, a property market slump, persistently lagging manufacturing sector which contracted for the first time in two years in January 2015. Faltering demand from key export markets like Europe adds to the worries. The issues that plagued the economy in 2012 have actually resurfaced since the start of 2014.
To lift the cloud over the economy, the People's Bank of China (PBOC) surprised the global markets on February 4 with a cut in reserves requirement ratio (RRR) by 50 bps. The latest cut was the first comprehensive one in the Chinese economy after May 2012.
Moreover, to boost smaller companies, the PBOC announced an additional RRR cut of 0.5 percentage point for city commercial banks and rural banks. Agricultural Development Bank of China receives a further reduction of 4 percentage points. Australia & New Zealand Banking Group Ltd. economists expect the step to add about 600 billion yuan ($96 billion) to the Chinese banking system.
Prior to this, in November, PBOC had slashed one-year lending rate, for the first time in more than two years, by 40 bps to 5.6% and the deposit rate by 25 bps to 2.75%. The PBOC also gave Chinese banks more flexibility in setting the interest rates on deposits in November.
Last year, China also took some easing measures including a mini-stimulus package mainly targeted at railways and other construction investment and a tax relief for small enterprises. Moreover, China slashed the RRR for rural banks and focused on innovative rural financial products hinting at the transition to domestic growth from exports. However, all its policy measures were small in scale then and appear not to have contributed significantly to the GDP picture so far.
Market Reaction
Several market participants expect a few more RRR and interest rate cuts this year with more evidence testifying to the fact that Chinese growth will take time to pick up due to global growth concerns. After all, solid monetary easing becomes essential for China given the sagging inflation which fell to five-year low in November.
The sudden move by the People’s Bank of China, which echoes the easy policy era in China in the coming days, offered modest gains in the Chinese stocks. Several Asian markets have benefitted from this decision.
In the large cap sphere, iShares FTSE China 25 Index Fund (ARCA:FXI), iShares MSCI China Index Fund (NYSE:MCHI) and SPDR S&P China ETF (NYSE:GXC) all added about 1% in the key trading session. The more local China A-Shares ETFs Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (NYSE:ASHR), Market Vectors China ETF (NYSE:PEK) and PowerShares China A-Share Portfolio (NYSE:CHNA) have tacked on better gains in the range of 1% to 2.4%.
Turnaround Possible in New Year?
Those hoping for a turnaround might look forward to the Chinese New Year in late February this year against last year’s late January. This should boost Chinese spending, especially with the greater availability of cash following the latest rate cut. However, over the long run, the situation might moderate. We would like to take a wait and see approach for the broader China ETFs space given a sluggish global economy, though the U.S. demand looks strong.
There are a number of headwinds still facing the Chinese economy, including shadow-banking activities and money laundering from mainland China to other peripheral destinations like Macau. A group of economists believe that the government’s excessive focus on anti-corruption activities may in fact hold back GDP growth.
Whatever the case, we expect a host of small easing measures now and then from the PBOC as we progress along the year and as the economy comes up with downbeat readings. And whenever this happens, the market should warm up.
Chinese equity ETFs are undervalued at the current level with the biggest ETF FXI trading at a
P/E (ttm) multiple of 10 against the broader emerging market ETF iShares MSCI Emerging Markets (ARCA:EEM) P/E (ttm) multiple of 12. So investors might have a short-term bet on the aforementioned ETFs to cash in on twin opportunities – the RRR cut and the other New Year spending spree.