After exhibiting improvement since late last year, the most recent Chinese economic data have deteriorated on the margin. This is largely due to changes in policy stance. Policies implemented late last year induced a quick growth acceleration, which are now prompting the authorities to switch back to focusing on “supply-side” reforms.
The Chinese authorities are struggling to perform a difficult balancing act. Through their reflationary policies, they are trying to push overall growth close to potential. However, at the same time, policymakers want to avoid “lifting all boats”.
Case in point is the steelmakers. Widely viewed as a sector with a hopeless excess capacity problem that urgently needs to be consolidated, steelmakers have witnessed a sudden bounce in profitability since late last year when Chinese reflation began to gain momentum. The authorities are concerned that policy reflation will simply prolong the lives of these supposed “zombie” firms, and the tough decision to cut their lifelines will still need to be made in the coming years once the current round of policy reflation runs its course. Worse still, if these sectors continue to expand capacity with the latest policy help, it will further worsen the situation when the day of reckoning finally arrives.
In other words, as “cutting overcapacity” is one of the key objectives of Xi Jinping’s “supply side reforms”, aggressive cyclical policy reflation appears to be in conflict with this longer-term consideration. In this vein, it may be comforting for the “supply-siders” that the sudden rebound in steelmakers and some other sectors such as construction materials and earth-digging machines have quickly rolled over. This should at least ease concerns over bailing out “zombie” companies.
Looking forward, our China strategists continue to argue against any policy tightening and major growth disappointment, but investors should also curb their enthusiasm in assessing China’s demand-side countercyclical initiatives.