local governments

Activity data was very weak The main body of activity data can be summed up in one word. Disappointing. Retail sales is the figure we have been focussing on, as it is at the moment, the only functioning engine of Chinese growth. And although the year-on-year growth rate of 12.7% looks impressive, this equates to a seasonally adjusted decrease in month-on-month sales and shows that the re-opening momentum is falling.  Breaking the numbers down to look at what is driving growth, and catering is still the major driver, which won't do a lot to boost domestic production and manufacturing, though it does lift GDP. Vehicle sales is the only other notable contributor to growth, after which very little else is showing much signs of life, including consumer confidence bellwethers, like clothing.    Industrial production rose 3.5%YoY, though this was well down on the 5.6% rate of growth in April, and the year-to-date growth figure was unchanged at 3.6%.  Urban fixed asset investment slowed from 4.7% to only a 4.0% pace, which may illustrate the problems local governments are having trying to boost growth in the absence of cash from land sales. Some more central government support may be of help here if it is forthcoming.    Also, property investment continues to weaken and is now falling at a 7.2%YoY pace, down from -6.2% in April. We had been hoping for more of a flat line from property development in China in 2023 after what we calculate was about a 1.5pp drag on GDP growth in 2022. It could be worse than this.    Contribution to year-on-year retail sales growth

China: Loan prime rates lowered Following the earlier reduction in 7-day reverse repo rates and the 1Y medium-term lending facility (MLF), today was the turn of the loan prime rates (LPR) to be cut by 10bp - more cuts will follow.   Rates all coming down After lowering the window guidance for banks on deposit rates recently, this week has also seen the policy 7-day reverse repo rate reduced, the 1Y medium-term lending facility (1Y MLF) reduced, and today, the 1 and 5Y loan prime rates reduced. This brings to an end this round of formal rate reductions, though more will likely follow in the months ahead as the economy continues to struggle.   China's monetary policy framework is a little tricky to understand if you are used to a single rate like the US Federal funds rate, or the ECB's main refinancing rate as the point around which all other interest rates and bond yields tend to pivot. But in recent years, it has moved in the direction of a more market-based system, as this note, and the amended chart which we have borrowed from the People's Bank of China (PBoC) try to explain.   The 7-day reverse repo rate and the 1Y MLF are set with a view to driving money market rates and credit/bond market rates. Loan prime rates are the rates on which mortgage yields are based. The standing lending facility rate (SLF) is equal to the 7-day repo rate plus 100bp, and is the cap for the interest rate corridor, while the 7-day reverse repo forms the floor. Deposit rates for savers are notionally set by banks but within ranges indicated by the PBoC - the so-called window guidance.   So, there is a market mechanism at play, but the monetary framework is also subject to a lot more direct control by the PBoC than in many economies.   China's interest rates     A lot of action, but will it help? The first point to note is that despite all of the rate-cutting in recent days, we are only talking about 10bp of easing and a bit of increased loan issuance. This isn't going to do an awful lot to boost the struggling economy, though it clearly is better than nothing. Even with further reductions, and we expect more of the same in the coming months, perhaps several iterations of cuts, it is not likely that we will see demand for property swing around strongly, construction will likely remain weak, and local governments will continue to feel the pinch from reduced land sales and tight finances, limiting their ability to pursue expansionary infrastructure projects.   That said, lower mortgage rates will provide a little additional cash flow boost to households and help retail sales and consumer spending to provide some support. And at least China is not having the same spending-power-sapping inflation problems that the rest of the world is suffering from, so there are few impediments to further cuts in policy rates save the political desire not to overdo it and stoke bubbles in parts of the economy. The risk of that happening at the moment seems very low. That said, the current rate of retail sales growth does look to contain a fair bit of pent-up demand following the economy's re-opening at the end of last year, and it is likely to weaken in the months ahead. Further rate cuts may help to soften the adjustment downwards when it comes.    The reduced rate backdrop will likely continue to weigh on the CNY, at least until US Fed policy also turns lower, so we will probably need to make further amendments to our USDCNY profile, keeping it weaker through 3Q23 and maybe softening the turn when it comes.        

More hints pointing towards the end of regulatory crackdowns for China’s Big Tech In addition, Chinese Premier Li Qiang held a meeting yesterday, 12 July with senior management executives from China’s leading technology companies such as Alibaba Group, Meituan, ByteDance, and Xiaohongshu Technology to discuss how the business operations of the technology sector can help to promote growth in the current lacklustre internal demand environment seen in China. During the meeting, Premier Li urged local governments to provide more support to these technology firms, labelling them as the “trailblazers of the era” and in turn, urged these technology firms to support the real economy through innovation. He added that the government will create a fair environment and reduce compliance costs in order to promote the sound development of the platform economy. Hence, yesterday’s Premier Li meeting has solidified China’s top policymakers’ current stance since last Friday of a more hands-off approach towards China’s Big Tech especially in the e-commerce, fintech, and platform sectors, and an indication the prior three-year of stringent regulatory crackdowns on their business operations have ended.   A weak external environment may still put downside pressure on China’s growth This latest rhetoric from the top man of China’s State Council is likely to boost positive animal spirits in the short-term at least. From a medium-term perspective, the external environment also needs to be taken into consideration when global interest rates are likely to stay at a higher level for at least till the second half of 2024 given the latest hawkish monetary policy guidance from major developed countries’ central banks, the Fed, ECB, and BoE. Therefore, a higher cost of global funding environment is likely to be persistent throughout 2023 and stretch into early 2024 which may continue to put downside pressure on China’s economic growth which is evident in the latest exports data for June which has continued to contract deeper to -12.4% year-on-year from -7.5% recorded in May, its steepest drop since February 2020 and came in below expectations of -9.5%. Hence, the current momentum-driven rally seen in the China Big Tech equities and Hang Seng benchmark stock indices may not oscillate in a smooth trajectory path.  

FX Daily: European pessimism, Chinese optimism In quiet markets ahead of G3 central bank meetings later this week, currency pairs are being driven by the soft set of eurozone July PMIs and also the prospect of some renewed Chinese stimulus after China's Politburo promised 'counter-cyclical' measures. These look like short-term trends. We would wait for the policy meetings to set the true FX tone.   USD: China stimulus – here we go again In quiet markets ahead of G3 central bank meetings, the FX market's focus has once again fallen on China. Having broadly disappointed investor expectations this year, China's economy is seen as enjoying a lift after China's Politburo yesterday promised 'counter-cyclical' measures. These follow a drip feed of support measures over recent weeks, such as the easing of restrictions in the mortgage sector, the encouragement to buy cars and electronics, and perhaps some support to local governments saddled with debt. None of these seem to be a game-changer so far, but the market optimists are hoping that this new directive from the Politburo will be turned into powerful stimulus at the State Council level.  Tellingly, USD/CNH did not move much when these measures were announced during the European session yesterday, but Asian investors are running with the story and driving the renminbi some 0.6% higher this European morning. Chinese equities are having a decent run too. These short-term trends may well fizzle out – we've been here before with prospects of China stimulus – but they could provide some mild support to emerging market and commodity currencies through the session. The reason why we warn against pursuing a full 'risk-on' rally in Rest of World (RoW) currencies is that the European economy looks weak and tomorrow's FOMC meeting will probably see the Fed's foot remaining firmly on the monetary brakes. Additionally, there was an overnight Wall Street Journal article by Fed watcher Nick Timiraos entitled: 'Why the Fed isn't Ready to Declare Victory on Inflation' – perhaps a nod to a still hawkish FOMC statement tomorrow.  Today's US data releases are second tier, but the consensus is expecting a decent tick-up in the July consumer confidence reading. As in the UK, there is a growing sense that consumers have so far been able to handle the pain of higher rates, diluting the case for any early easing cycles.   DXY can trade a tight 101.00-101.50 range ahead of tomorrow's Fed meeting.

Is China on path for longer economic stagnation?  By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank   Released yesterday, the latest CPI data showed that the headline inflation in the US ticked higher from 3 to 3.2%. That was slightly lower than the 3.3% penciled in by analysts, core inflation eased to 4.7% in July from 4.8% expected by analysts and printed a month earlier.   But the rising energy and crop prices threaten to heat things up in the coming months and inflation's downward trajectory could rapidly be spoiled. That's certainly why an increasing number of investors and the Federal Reserve's (Fed) Mary Daly warned that this was 'not a data point that says victory is ours'.   And indeed, looking into details, the fact that the 20% fall in gasoline prices is what explains the decline in headline number is concerning. The barrel of US crude bounced lower yesterday after a 27% rally since the end of June, and the latest OPEC data indicated that we would see a sharp supply deficit of more than 2mbpd this quarter as Saudi cuts output to push prices higher. And this gap could further widen as global demand continues growing and shift to alternative energy sources is nowhere fast enough to reverse that upside pressure.   On the other hand, we also know that the rising energy prices fuel inflation expectations and further rate hikes expectations around the world. And that means that oil bears are certainly waiting in ambush to start trading the recession narrative and sell the top. The $85pb could be the level that could trigger that downside correction despite the evidence of tightening supply and increasing gap between rising demand and falling supply.   Today, eyes will be on the July PPI figures before the weekly closing bell, where core PPI is seen further easing, but headline PPI may have ticked higher to 0.7% on monthly basis, probably on higher energy, crop and food prices.     In the market  Yesterday's slightly softer-than-expected inflation numbers and the initial jobless claims which printed almost 250K new applications last week - the highest in a month - sent the probability of a September pause to above 90%, though the US 2-year yield advanced past the 4.85% level, and the longer-terms yields rose with a weak 30-year bond action, which saw the highest yield since 2011.   Major stock indices stagnated. The S&P500 was up by only 0.03% yesterday while Nasdaq 100 closed 0.18% higher, as Walt Disney rallied as much as 5% even though Disney+ missed subscription estimates and said that it will increase the price of the streaming service. Disney is considering a crackdown on password sharing, which, combined with higher prices could lead to a Netflix-like profit jump further down the road.     In the FX  The USD index consolidates above the 50 and 100-DMAs and just below a long-term ascending channel base. The EURUSD sees support at the 50-DMA, near the 1.0960 level, and could benefit from further weakness in the US dollar to attempt another rise above the 1.10 mark.   European nat gas futures fell 7% yesterday after a 28% spiked on Wednesday on concerns that strikes at major export facilities in Australia could lead to a 10% decline in global LNG exports. Yet, the European inventories are about 88% full on average and the industrial demand remains weak due to tightening financial conditions imposed by the European Central Bank (ECB) hikes. Therefore this week's massive move seems to be mostly overdone, and we shall see some more downside correction.     Chinese property market is boiling  The property crisis in China is being fueled by a potential default of Country Garden, which is one of the biggest property companies in China and which recently announced that it may have lost up to $7.6bn in the first half of the year as home sales slumped and the government stimulus measures didn't bring buyers back to the market. Equities in China slumped further today, as property crisis is not benign. In fact, China's local governments have plenty of debt, and their major source of income is... land and property sales. Consequently, the property crisis explodes local governments' debt to income ratios- And the debt burden prevents China from rolling out stimulus measures that they would've otherwise, because the government doesn't want to further blast the debt levels.   Shattered investor and consumer confidence, shrinking demographics, property crisis and deflation hints that the Chinese economy could be on path for a longer period of economic stagnation. We could therefore see rapid pullback in investor optimism regarding stimulus measures and their effectiveness. Hang Seng's tech index fell to the lowest levels in two weeks yesterday, as all members fell except for Alibaba which jumped after beating revenue estimates last quarter.   

ZUE is a general contractor operating in the rail and tram infrastructure sector. Recently, the company has become the only WSE-listed company not under the control of stateowned infrastructure entities for which this is a leading business. The current year is significant in two respects: i) completion of the "difficult" contracts of 2017, ii) geographic diversification. The company is in the final stages of completing orders signed in 2017, which are either being officially finalized or should be completed in Q4'23. These have burdened results for the past few years. ZUE has won rail orders in the Romanian market in 2022, which should be more clearly visible in revenues from 2H'23. They account for about 30% of the company's backlog after 2Q'23. Entering Romania involves, among other things, risks specific to the market there, but at the same time, we believe that this may eventually be a successful step for the company to enter foreign markets. ZUE's current enterprise value (EV) is about PLN 150 million. This amount is lower than the sums of fixed assets and net working capital. We currently set the fair value (target price) of ZUE's shares at PLN 7.76, implying a Buy rating. The valuation does not take into account possible claims and valorisation from PKP PLK (lawsuits filed for PLN 93m, about PLN 4.0/share). ZUE's order backlog amounted to PLN 1.46 billion after Q2'23. The company has a pending contract worth PLN 0.79 billion with PKP PLK (CEF financing). We estimate that the current backlog is more or less evenly split between rail contracts in the Romanian market / rail contracts in Poland / urban contracts (tram), at about 30% each. The remainder is made up of maintenance contracts and trading company orders. We note that the company's execution portfolio still includes contracts signed in 2017, from a period when competition on tenders was very demanding. These contracts recorded significant delays compared to the original schedules. We estimate that the value of work on these contracts may still amount to about PLN 30-50 million as of 2H'23. On previously completed contracts from a similar period and still from the previous EU perspective, the company has filed lawsuits and valorisation claims for about PLN 93 million. This figure does not include potential claims on contracts currently being completed. Contracts in the Romanian market were signed by the company in late 2022/23 (tenders were bid in Q3'22, when concerns about cost increases were high and bids were cautious). At the time of signing, they had a total value of about PLN 490 million for ZUE. These contracts are not technically complex (replacement of track infrastructure), and have a built-in valorisation index. Entering the Romanian market is not ZUE's first approach to foreign markets. A few years ago, the company had already executed a medium-sized contract in Slovakia, earlier it had also had an approach in the German market (which in the next few years may become more open to Polish companies in the field of network electrification due to the lack of local capacity) or for many years it has been observing the Bulgarian direction. In recent months, the first Latvian contract was also secured (the Baltic market may be very absorptive in the coming years due to the construction of Rail Baltica, which will also be accompanied by smaller local investments). In 1H'23, the company generated PLN 542m in revenue (+45% y/y) and PLN 4.1m in net profit. We expect that in 2H'23 the y/y revenue dynamics may slow down (the backlog is currently marginally lower y/y), while we expect profitability to improve (decline in importance of "difficult" contracts, gradual emergence of revenues from Romania with declared higher-than-average margins). We assume that in 2023 the company will generate PLN 1.1 billion in revenues and PLN 11.8 million in net profit. In 2024, we expect similar revenues and PLN 13.3 million in net profit. We take a conservative view on the backlog for 2024-25 at this point.     The launch of EU funds would solve the sack of tender procedures in the tram market on the part of local governments, and would significantly accelerate the settlement of tenders on the part of PKP PLK.    

In this market pulse, we delve into the complex terrain of China's property debt overhang, examining the challenges faced by giants like Evergrande. We also assess the current economic momentum, highlighted by positive indicators and upcoming Purchasing Managers' Index (PMI) data releases. Moreover, we emphasize the pivotal role of impending crucial meetings, including the Third Plenary Session and the 6th National Financial Work Conference, in shaping China's economic policies.   Key Points: Examining the enormity of China's property debt crisis, including Evergrande's challenges. Highlighting recent signs of recovery and the significance of the upcoming PMI data. Previewing the upcoming Third Plenary Session and 6th National Financial Work Conference. Introduction China Evergrande's ongoing financial troubles and defaults have once again taken center stage, casting a dark cloud over the equity market. Meanwhile, China's economic recovery is showing signs of life, with attention turning to key economic indicators like the Purchasing Managers' Index (PMI). In addition to these economic developments, several crucial meetings on China's economic and financial policies are on the horizon. This article will delve into these topics, providing an analysis of the current situation and what lies ahead. China Property Developer Debt Overhang China Evergrande, one of the nation's largest property developers, has recently made headlines due to its inability to meet regulatory qualifications for issuing new debt. This situation escalated when its mainland unit, Hengda Real Estate Group, failed to make a scheduled payment of RMB4 billion in principal and interest. The broader issue here is the massive debt overhang in the Chinese property sector, totaling RMB60 trillion. A significant portion of this debt, RMB40 trillion, consists of mortgage debts that are relatively less risky for banks as long as the pre-sold units are completed and delivered to buyers. The focus for Chinese authorities is to resolve these pre-sold units to ensure contractors get paid and homebuyers receive their properties. The completion of unfinished housing projects requires substantially additional funds, estimated to be over RMB2 trillion, which may be shared by state-owned enterprises that take over the projects, local governments, and the central government. However, the more problematic area is the RMB20 trillion in property developer debts. It's highly unlikely that China will bail out insolvent property developers. Instead, these developers and their banks will likely sell encumbered projects, along with their loans, to stronger entities, often state-owned enterprises with government backing. The recent regulatory easing on housing demand may stabilize the housing market to some extent. Still, the overhang of housing inventories in lower-tier cities facing population decline will persist for several years. This will lead to more headlines about defaults, restructuring, and liquidation of insolvent developers, causing losses for shareholders, bondholders, banks, and investors in trust and wealth management products tied to property projects. Some trust companies and private equity funds in the shadow banking sector may be subject to losses detrimental to their financial viability. While the banking sector, which holds around 75% of the RMB20 trillion developer debts, has sufficient capital buffers to absorb losses, the extent of the impact will depend on the successful liquidation of housing inventories by insolvent developers to stronger entities, likely brokered by local governments. This process is expected to negatively affect the profitability of banks in China. Economic Momentum and PMI Data Recent economic indicators have shown signs of improvement in the Chinese economy. The Citi China Economic Surprise Index (Figure 1) has rebounded, indicating fewer instances of economic data falling below expectations. As discussed in last week's Market Pulse note, retail sales, industrial production, trade, and inflation data improved in August.    The release today of a bounce in August industrial profit growth to 17.2% YoY (Figure 2), the first monthly year-on-year growth since June of last year, provides additional support for the pick-up in growth found in the industrial production released last week.