China trade slippage highlights growth deceleration risk

We learned today that China’s trade volume unexpectedly 3.1% year-on-year in June with both imports and exports down. This unexpectedly weak data point highlights the risk of growth deceleration in emerging markets generally and China specifically.

Here is how HSBC reports the data release according to the Wall Street Journal:

The simultaneous decline of exports and imports underlines the weakness of both external and domestic demand conditions. The last time that both imports and exports contracted was in October 2009 (stripping out Chinese New Year distortions). The current downside pressures to growth seem to be even larger than the mid-year slowdown in 2012 (when export growth almost faltered and imports temporarily contracted)…Going forward, external headwinds will likely persist…Policy response is crucial to avert a sharp deceleration of growth, especially as domestic demand continues to worsen… While a large-scale stimulus is off the table, Beijing policy makers signal that they will strike the balance between stabilizing growth and making structural adjustments. – Qu Hongbin and Sun Junwei, HSBC

I have been saying for some time that the risk to the global economy has moved away from Europe to EM and that China is not alone in its growth deceleration. With China, the problem is twofold. On the one hand it is axiomatic that growth will decelerate as China moves away from an export-led economic model to one more dependent on domestic demand. And we are seeing that. However, the last time, China looked to make this shift in 2012, the slowdown was so severe that policy makers relented and engineered another capital investment and export-led growth recovery. This time, policy makers seem more comfortable letting the credit bubble unwind, and that necessarily means lower growth, lower capital expenditure, and lower use of commodity inputs.

Gavyn Davies wrote insightful commentary yesterday, noting that he thinks China faces a difficult credit bubble workout ahead:

 Although China is probably not facing anything as dramatic as a “Lehman” moment, it will need to spend several years tackling the combination of excess credit and over-investment that has followed the Rmb4tn ($652bn) stimulus package of 2008. Hailed at the time as a masterstroke, the package has caused a hangover that has now been implicitly acknowledged by the new administration under reformist Premier Li Keqiang.

China is in the midst of a classic credit bubble. The ratio of total credit to gross domestic product has risen from around 115 per cent in 2008 to an estimated 173 per cent, an acceleration in credit expansion that has spelt danger in many other economies. Much of this has come in the poorly regulated shadow banking sector, where the annual rate of credit expansion exceeds 50 per cent. The Chinese authorities are signalling, correctly, that this must slow sharply.

My question is how long the Chinese authorities will allow this unwind process to continue before they feel forced to intercede. I believe the deceleration will be severe if unchecked. And this could boomerang back onto the global economy, particularly for countries dependent on China as the swing consumer of industrial commodities. Watch China more than Europe for now.