China: Heads I win, tails you lose – Rabobank

Michael Every, Head of Financial Markets Research at Rabobank, suggests that in China if painful reforms are about to start for real then even the  “L-shape” projection for growth for the next two years may be too optimistic.

Key Quotes

“The near-term impact to growth from such reforms is likely to be negative before it turns positive. The scale of industrial over-capacity and matching over-borrowing makes that clear. We are therefore more likely to see “U-“ or a “V-shape” than an “L-shape” (if “L” implies growth around the current official pace of 6.7%), though it depends on how fast and far such changes are introduced.

Indeed, if borrowing is reigned in then the ‘debt impulse’ will turn starkly negative. We have already seen how painfully that plays out in the highly-leveraged and increasingly cash-strapped Chinese economy, and the impact would be much worse now than it was last tried as debt is even higher and growth and profitability even lower, for the most part.

Meanwhile, the second scenario, a lack of reform, will arguably still mean an “L-shape” is hard to achieve. Despite the recent enormous increase in total borrowing growth rates are steadily-declining, and it is improbable that structural picture would change going forwards by itself. Moreover, at the same time there would be growing concern that China is perhaps unable to reform if such a powerful editorial from a “high official” is shrugged off. That would also potentially shake confidence.

From a financial market perspective both scenarios will entail further lowering of interest rates to try to cushion the impact on the economy. That would have significant implications for both asset prices, already prone to bubbles, and for the exchange rate, where things are looking far less bubbly.”