China’s economy falls into ‘confidence trap’ as corporates shun long term investment
China’s economy has fallen into a “confidence trap” as companies increasingly park their money in short term demand deposits due to declining confidence in growth prospects for the real economy, with the divergence between M1 and M2 growth now at its highest level on record.
Analysts suggest reviving confidence should hold the key to managing the “trap”, including cutting corporate taxes, shutting down zombie firms and debt restructuring efforts.
The gap between M1 and M2 growth has recently hit a record high of 15 percentage points. The M1 growth rose to 25 per cent in July, compared with 4.3 per cent in June last year, while M2 growth softened to 10.2 per cent in July, versus 13.3 per cent last June.
M1 and M2 are both key measures of money supply. M1 includes cash and checking deposits, while the broader M2 includes all elements of M1 as well as savings deposits, mutual funds and other less-liquid assets.
“[The rising divergence between M1 and M2 growth] reflects the corporate sector’s preference for short-term deposits, as companies are increasingly unwilling to make long-term business investment,” said analysts from HSBC in a recent research note.
The HSBC analysts disagreed with the argument that China has fallen into “a liquidity trap”, which suggests monetary policy has exhausted its usefulness. To the contrary, the fact that liquidity is pouring into short-term investment products indicates that demand for money is very robust, they said.
“We think the current predicament looks more like a ‘confidence trap’,” HSBC analysts said, noting that confidence is declining in prospects for a rebound in the real economy and thus companies are hoarding cash rather than spending it on capital investment.
According to recent statistics, China’s corporate profitability has fallen to a post-crisis low.
The combined net profits of the 2,911 companies listed on the Shanghai and Shenzhen exchanges fell 4.1 per cent to 1.4 trillion yuan (HK$1.625 trillion) in the first six months of the year, according to data compiled by Shanghai Wind Information Co. That’s the worst aggregate interim result in seven years.
Coupled with falling corporate profitability, China’s intensifying deflationary pressures also help create a sense of pessimism that has inhibited companies from making capital investment, HSBC analysts said.
“The prolonged downturn since 2012 and the corrosive effect this has had on corporate confidence has been the fundamental reason behind the shift in the structure of corporate liquidity over the past few years,” they said. “This process has been perhaps amplified by yield compression and by the strong rebound in housing sales since mid-2015.”
This shift in the structure of corporate deposits has played a key role behind the rising divergence between M1 and M2 growth over the past year.
In order to manage the confidence trap, the Chinese economy needs “confidence-inspiring policies”, including accommodative monetary policy and more vigorous fiscal expansion, such as meaningful cuts to corporate taxes and fees, shutting down zombie state-owned enterprises (SOEs), and faster debt restructuring.
“We would argue that now is a good time for fiscal policy to shoulder more of the responsibility in terms of supporting growth,” HSBC analysts said.
For instance, fiscal easing is the kind of targeted measure that can help channel liquidity
away from the banking system into the real economy. Moreover, the government could consider cutting taxes and fees for corporates in a more material way.
Recent suggestions for SOE equity transfers to the National Social Security Fund could help open up some space for the social security contribution to be reduced in the coming year to ease the burden for companies, the analysts said.