China economy improves in Q2 in credit crunch period

China's economy continued to improve in the second quarter, with corporate profits rising and hiring up, a private survey showed, but it suggested the Asian giant may have to brace for tougher times ahead even though firms have been able to weather a tighter financing environment.

To provide a more accurate read on China’s economy, Leland Miller and his team at China Beige Book International (CBB) interview thousands of companies and hundreds of bankers on the ground in China each quarter. They collect data and perform in-depth interviews with Chinese executives. The quarterly survey showed that while the property sector slowed, manufacturing improved further and the retail and services industries bounced back after a difficult first quarter.

That reinforced a flurry of recent data and policymakers’ comments that indicated authorities were working to curb financial risks and keep the economy on an even keel heading into a key political meeting this year.

The survey showed surprisingly strong performance in the commodities sector despite some price weakness in the second quarter, with the aluminium sector particularly strong.

“So far, 2017 has played out as a best-case scenario. … The remarkable absence of both domestic and foreign shocks has created the stable environment corporates need to outperform most expectations, including ours,” states a preview to the full Q2 2017 report.

However, despite the overall positive response from the firms surveyed by CBB, there are a few traditionally Chinese “extend and pretend” caveats to the rosy picture.

For example, every sector reported record inventories, which is positive for production and jobs, but not for sales. If the stocked products aren’t sold shortly, it will hit the companies’ bottom line.

“The same companies who report solid results on most indicators also continue to show cash flow in the red—corporate health has not yet responded to better growth,” states the CBB preview.

Then there is the credit market, a source of worry for China watchers since the end of last year. China’s bank borrowing rates have been creeping up from 3 percent to almost 4.5 percent since late 2016, and CBB notes that this is now affecting the bank’s corporate customers.

“In Q1 … credit tightening was limited to interbank markets. In Q2, it hit firms: Bond yields and rates at shadow banks touched the highest levels in the history of our survey, and bank rates their highest since 2014,” states the report.

But borrowing was not impacted much, CBB said, likely due to firms’ positive business outlook for the next six months, though CBB said that this may not last if tightening persists.

“Companies assume deleveraging is transient, likely because they are sceptical the Party will allow economic pain in 2017.

"It will not be until 2018 when we find out whether deleveraging is genuine because it won’t be until 2018 that it will actually hurt”, CBB said.