Is China about to launch a new round of stimulus?

July 30, 2016

By Ansuya Harjani, CNBC

China's growing economic malaise, reflected in the latest batch of weak manufacturing data, may trigger a fresh round of stimulus measures from the government as Beijing looks to defend its annual growth target of 7.5 percent, economists tell CNBC.

The China HSBC flash purchasing managers index (PMI) fell to an 11-month low of 47.7 in July from a June final reading of 48.2, as the world's second largest economy continues to reel from deleveraging and tight monetary policy.

"We do expect some support because now it's quite uncertain how China can achieve 7.5 percent (annual growth), which is the floor, without introducing measures to deal with the situation," Dariusz Kowalczyk, senior economist at strategist, Asia ex-Japan at Credit Agricole.

According to Jian Chang, economist at Barclays, economic support could come in a matter of weeks.

"Combined with the broad-based slowdown in economic activity in June, we expect more announcements from various government bodies in the coming weeks to support growth," Jian Chang, economist at Barclays wrote in a note on Tuesday.

A factor that could swing the balance in favor of government intervention is the continued weakness in the labor market. The China HSBC PMI employment sub-index came in at 47.3, which is at a 52-month low.

"Employment conditions are more important for the government than output so deterioration here further boosts odds of stimulus," Kowalczyk said. Earlier this month, Frederic Neumann, co-head of Asian economics research at HSBC, said people worried about a hard landing in China as "policymakers sit on their hands," should remember that joblessness is something the Communist Party of China takes very seriously.

"They're less worried about growth in itself, they're much more worried about the severity of the job market," Neumann said. "So, if there are signs that the job market buckles, they will step on the gas and try to lift growth again, because that's obviously the number one risk in China."

What measures to expect

According to Dariusz Kowalczyk, senior economist at strategist of Asia ex-Japan at Credit Agricole, the government is not likely to launch extensive stimulus measures. He is expecting the government to step up fiscal spending in the third quarter.

Ting Lu, China economist at Bank of America Merrill Lynch agrees that Beijing will resort to fiscal stimulus, but not on a grand scale.

"We reckon that he could introduce a small scale fiscal expansion by tapping the central government coffer to support social housing, railway, environment related urban infrastructure such as sewage and IT infrastructure such as broadband and 4G," Lu said.

Other measures could come in the form of encouraging the Chinese currency to depreciate and perhaps a cut to the central bank's reserve requirement ratio (RRR) later this year, analysts say.

"The PBoC has likely realized that exporters are not as competitive as the inflated data from earlier in the year suggested and cannot withstand the current strength of the yuan. Policymakers are likely to help exporters by stabilizing the CNY if not orchestrating a modest correction lower," said Kowalczyk.

Kowalczyk also anticipates the People's Bank of China to loosen liquidity conditions in the fourth quarter by cutting the RRR by 50 basis points.

But Zhiwei Zhang, chief China economist at Nomura, has a more aggressive forecast, saying RRR cuts of 100 basis points in the second half can't be ruled out.

"We believe China will experience a prolonged period of capital outflows in the second half of 2013 and first half 2014 as growth slows and investors worry about a potential economic hard landing in China. The People's Bank of China will need to cut the RRR to offset the negative effects from capital outflows on domestic liquidity conditions," Zhang wrote in a note published earlier this week.