The soft July data have once again generated expectations of monetary easing from China. Goldman however thinks further monetary easing would have incrementally less of an impact and would come at the cost of financial stability. This diminishing impact, they argue, would result as overcapacity/oversupply restricts long-term borrowing demand and due to interest rate deregulation, which tends to move the long-term risk-free interest rate to a higher equilibrium, as seen in recent data. As the tradable sector continues to recover on the back of an improved global outlook, Goldman believes that a combination of sectoral policies aimed at easing financial stress and structural adjustment would be a better policy option. They do not expect broad macro easing or an interest rate cut in what remains of this year.
Goldman’s Li Cui Explains…
Better global growth has supported recovery, while domestic demand is still soft
Recent data show that the impact of earlier policy easing was short-lived, and domestic demand has remained soft. For July, in particular, most indicators related to domestic demand – including investment, financing and imports – decelerated notably from the previous month. Industrial production held up but this was most likely a reflection of stronger exports rather than domestic momentum. While one monthly data point does not signify a trend, the underlying picture is clear: Chinese exports have seen a visible recovery since last year, cushioning the impact of the domestic slowdown, in line with our expectation.
Given soft domestic momentum, market attention has again turned towards the potential for further monetary easing, including liquidity easing and a cut in interest rates. However, recent experience suggests that monetary easing is likely to have a limited impact on the growth recovery, as we have argued elsewhere. The credit rebound in May-June and the decline in July were entirely driven by short-term borrowing. Long-term borrowing corresponding to corporate capex and infrastructure construction has been muted, and stands at 15.5%yoy, compared with 17.3% at the end of 2013. Thus, long-term investment has continued to decelerate despite monetary easing. Along with the elevated long-term borrowing costs discussed below, this suggests that monetary easing has yet to produce a lasting impact on economic demand. The relief through higher short-term loans has mostly benefited enterprises with working capital needs, in particular companies in sectors with overcapacity.
