Last week, the People’s Bank of China (PBoC) fired up its easing guns by making use of three monetary policy tools. First, the central bank cut the Reserve Requirement Ratio (RRR) by 0.25%.
Next, it slashed its benchmark interest rate by 0.31%. And last, the central bank offered 5 billion CNY in reverse repo agreements.
The PBoC normally employs one form of easing at a time, which makes its recent moves very odd. The PBoC’s aggressive moves seem to suggest that the central bank is worried about the economy. Judging by the state of China’s economy, the PBoC will probably follow up with more easing soon. Here are a few reasons why:
1. Disappointing economic performance
Most economic indicators from China have been showing weakness. China’s official manufacturing PMI fell to 50.2 after it had printed a 50.4 reading the month before.
Meanwhile, HSBC’s version actually plunged below the 50.0 mark. Remember, the 50.0 level is the dividing line between growth and contraction.
GDP data isn’t any better. Growth for Q2 2012 is anticipated to slip to 7.9% from 8.1%–very alarming for a country that’s used to seeing double-digit growth.
The country’s inflation figures share the same disappointing story. The most recent Consumer Price Index failed to meet the forecast as it came in with only a 2.2% gain. The market had initially expected a 2.4% increase.
2. Threat of deflation
Speaking of inflation, China’s Consumer Price Index dropped to its lowest point in 29 months in June. The Producer Price Index is faring even worse. In June, the PPI fell 0.7% month-on-month and 2.1% year-on-year. This marked the fourth straight month of deflation and has pushed the PPI to a 31-month low.
Some economists are predicting that China could fall into the same deflation trap it experienced between February and October of 2009. During this period, the economy saw its slowest growth since 2002.
3. High inventories signal weak demand.
With PMIs signaling slower manufacturing activity, inventories pile up as demand for raw materials and energy fall.
For instance, stockpiles of coal in power plants reached the full warehousing capacity in several Chinese provinces and even reached a record high of 9.4 million tons in Qinhuangdao, one of China’s largest ports.
Other sectors such as the textile industry are also suffering from weak domestic demand and growing stockpiles. With that, small and medium textile factories are being forced to cut down production while some are left with no choice but to close shop.
4. Risks from other major economies
Of course let’s not forget that external factors like the eurozone debt crisis continue to weigh China down, along with the rest of the global economy. Although many are hoping that Asia could show signs of stronger growth, China’s neighbors don’t seem to be faring so well either, which means that the region’s prospects could also be shaky.
For example, Japan recently reported a disappointing current account surplus in May, its weakest reading since 1985. On top of that, Japanese machinery orders slipped by a whopping 14.8% in May, indicating a downturn in capital spending. Hong Kong, another strong economy in the Asian region, hinted that it may miss its growth target for 2012 and that its central bank might have to cut borrowing costs.
Even though the latest reports paint a very grim economic picture for China, the PBoC might still decide to wait at least a month to see if their most recent easing efforts could do the trick.
But if the state of the global economy continues to worsen, China might have to work harder to maintain its soft landing and come up with more creative ways to spur growth. Until that happens, the prospect of China having growth troubles could keep driving risk lower.