As we hit the third anniversary of China’s summer horribilis, history appears to be repeating itself. Share prices are again plunging, as is the renminbi. But this is no replay of those chaotic months of 2015, when the collapse of a stock market bubble and a botched currency devaluation sent shockwaves through the Chinese economy, and through global markets. 

Risks are rising, particularly given the uncertainties surrounding US trade policy towards China, and Beijing’s response to any punitive actions. But the economic backdrop is still reasonably benign, even though the latest haul of monthly data from FT Confidential Research suggest activity continued to decelerate in June from robust rates of growth seen at the start of this year. 

The authorities have signalled that they are prepared to relax policy, but have so far only taken small steps to ease the strains caused by their campaign to curb risky lending practices, which remains the policy priority. 

Our June Business Activity Index, which is an aggregated read of our monthly survey results, fell 2.1 points month on month to 51 as all three of its components weakened from the previous month.  Export conditions were softer than in May as more companies reported weakness in new orders while our  freight index fell to a 10-month low, with the most respondents warning freight volumes were affected by shrinking business since August 2016. 

Consumer sentiment suffered in response to gloomy headlines about trade wars and a slumping stock market. However, our measure of discretionary spending strengthened while the headline consumer index remained well above its levels of a year ago levels. Our survey has previously highlighted the vulnerability of sentiment to sharp changes in asset prices, but consumers are far more invested in the housing market than they are in A-shares. So long as  house prices are buoyant— and they were in June — consumers should remain upbeat. 

Relief with strings attached

The government has not sat on its hands as markets have sold off, but nor has it been overly generous in its support. Import tax cuts and plans to ease the household income tax burden are part of longer-term plans to boost consumption. More immediately, the third reserve requirement ratio cut this year was announced on June 24 and will release around Rmb700bn back into the financial system. Historically, lowering the reserve ratio has been the recourse of a government panicking about the economic growth picture. Cuts in 2015 and 2016 were accompanied by official commentary making clear they were in response to faltering growth. 

But this year’s moves have come with strings attached which suggest stimulus is not the intention. Most of the funds released in April’s cut were designed to help banks pay down more expensive borrowing from the People’s Bank of China. This latest move stipulates that big banks fund debt-equity swaps with indebted companies and that smaller lenders use the funds to lend to small firms. Funding problems resulting from the deleveraging have seen 25 bonds, with combined face value of Rmb25.3bn ($3.8bn), default so far this year, 47 per cent more than during the same period in 2017. It remains to be seen if small companies do benefit from these measures — banks typically prefer to lend to real estate, where the risks are perceived to be lower. 

Although investors risk underestimating the new financial leadership’s determination to hold the line and clean up the system, they should expect more direct policy easing if this year’s 6.5 per cent growth target comes under threat or if this relative trickle of defaults becomes something more destabilising. But easing policy too aggressively also raises the threat of capital outflows. 

Three years ago, the government was forced to tighten capital controls and spend $1tn in foreign exchange reserves trying to stabilise the financial system. That was the teachable moment of 2015 and 2016 and one the authorities will not want to repeat. 

The FTCR China Business Activity Index is a composite reading of business activity and sentiment based on our surveys of companies in the real estate, export and freight sectors. For individual survey methodologies click here. A full set of survey results can be found in our Database.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.