Bringing State Investment Back to Normal

CHINA - Report 28 Jul 2014 by FAN Gang and Chunyang Wang

Executive Summary

In June the government increased investment, and lowered the reserve requirement ratio for banks. Instantly, fiscal spending and the money supply rose. Though the real economy has not been affected (when taking the lagged effect into account), a future rebound is certainly possible.

Principal Q2 economic indicators are relativelystable. GDP was up 7.5% y/y, and industrial output was up 9.2% y/y in June. Fixed asset investment increased 17.6% y/y in June, slightly above rises for April and May.

Retail sales of consumer goods rose 12.4% y/y in June in nominal terms, down 0.1 pps from May. Exports in dollars rose 7.2% y/y, virtually flat on May. Adjusted export growth was stable in H1. We expect exports to strengthen, as shipment value for industrial product exports rose 8.5% y/y, up significantly. But imports were still weak.

CPI rose 2.3% y/y in June, down 0.2 pps from May. The ex-factory price index of industrial products in June was down -1.1% y/y, and PPI was down -1.5%, continuously narrowing for three consecutive months, but still in deflation mode.

The money supply increased dramatically, largely due to the lowered reserve requirement ratio. M2 rose 14.7% y/y, up 1.3 pps from May. M1 rose 8.9% y/y, up a significant 3.2 pps. However, the money supply increase in June came mainly from alternative financing channels, not bank loans.

Prime Minister Keqiang Li chaired a State Council executive meeting June 16th, and listened to inspection reports, in order to rectify the implementation of the government reform and growth plans promulgated in earlier this year. He stressed the need for all branches and levels of government to do solid work, and to be responsible for seeking practical results. The meeting was held in response to lowered government investment, and to slower fiscal spending: some government projects are far behind schedule. Unlike other analysts, we argue that the recent fiscal expansion is not a so-called “mini stimulus,” but a response to government officials’ slow action, and an effort to lift investment demand back to normal. There is no increase in the fiscaldeficit, but actually a surplus in H1, due to reduced government spending: only about 30% of budgeted spending was executed in H1.

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