The OECD’s composite leading indicator indices are showing brighter signs, consistent with the view here that global economic growth will recover after a weak start to 2016.
Available data suggest that two-quarter GDP growth in the G7 major countries and seven large emerging economies (the “E7”) slipped to its lowest level since 2012 in the first quarter of 2016. (Growth is measured over two quarters to reduce volatility.) G7 plus E7 industrial output, meanwhile, was stagnant over the six months to March – see first chart.
The second chart shows changes in industrial output and a G7 plus E7 leading indicator based on the OECD’s country data. Six-month growth of the indicator rose again in March, having bottomed in November 2015. The one-month indicator change also continues to firm.
The upturn in leading indicator momentum is consistent with a rise in G7 plus E7 six-month real narrow money growth from a low in August 2015 – third chart. The latter pick-up was noted in a post at end-2015, which concluded that “global economic momentum will remain soft in early 2016 but rise in the spring / summer”. (Note that real narrow money has expanded consistently faster than industrial output / GDP in recent years, reflecting super-low interest rates, which have reduced the opportunity cost of holding demand / sight deposits and physical cash. Changes in real money growth, however, continue to foreshadow changes in economic expansion six to 12 months ahead.)
The stronger signal from the leading indicator mainly reflects an upturn in the E7 component, although G7 weakness is abating. The OECD’s Chinese leading indicator, in particular, is giving a positive message, consistent with an earlier upswing in real narrow money growth – fourth chart. A recent resurgence of pessimism about Chinese economic prospects appears premature, at least.
China pessimists argue that the authorities’ efforts to stimulate the economy have resulted in another unsustainable credit boom. The credit surge, they claim, has merely delayed an economic downturn and increased its probable magnitude, while further weakening banks’ balance sheets. Are they right?
Widely-monitored credit / financing measures do not suggest a renewed lending explosion. Annual growth of renminbi bank loans to households and non-financial enterprises was 14.5% in March, close to its average of 14.9% over 2011-15 (five years). Annual growth of “total social financing” – a broader measure of fund-raising by households and non-financial enterprises encompassing non-bank loans and issuance of bonds, acceptances and equities – was 13.4%, significantly lower than its 2011-15 average of 17.3% and far below a 35% peak reached in 2009.
The pessimists, however, highlight a less widely-followed series measuring total domestic credit extended by banks. This rose by an annual 25.4% in March versus average expansion of 17.4% over 2011-15. Recent growth is the fastest since the 2009-10 credit boom – see first chart.
The big divergence between the growth of this measure and that of bank loans to households and non-financial enterprises reflects a surge in credit to the government and the non-bank financial sector. Bank credit to government, net of government deposits at banks, rose by an annual 87.4% in March, contributing 4.3 percentage points to the 25.4% growth of total domestic bank credit. Credit to the rest of the financial sector, meanwhile, rose by 68.3%, contributing 8.2 percentage points to total credit growth.
The increase in government credit is partly a consequence of fiscal stimulus. The authorities have responded to a weak economy by running an increased budget deficit financed through the banking system.
The government credit surge also reflects the impact of the local government debt swap programme, under which municipal authorities have been issuing bonds, mostly bought by banks, with the intention of retiring more expensive bank loans incurred by their subsidiary enterprises (local government financial vehicles). These subsidiaries are classified as “non-financial enterprises” so their borrowings are covered by the headline RMB bank loans and total social financing measures. To the extent that debt has been repaid, annual growth of these measures will have been “artificially” depressed, possibly by several percentage points. Even adjusting for such an effect, however, growth would not be particularly strong by the standards of recent years.
The rise in government credit, therefore, is unconcerning and may be serving to improve the quality of banks’ assets, since government lending has the implicit backing of the central authorities (unlike loans to local government financing vehicles).
The surge in credit to the non-bank financial sector is more worrying. An FT article this week suggested that banks have been using “investments” in intermediaries such as trust companies, brokerages and special purpose vehicles to hide risky loans to households and non-financial enterprises. Such investments or “debt receivables” are classified as credit to the financial sector. The FT stated that the banking regulator is cracking down on this practice and will require banks to make full provision for debt receivables based on loans.
However, while the acquisition of such investments has increased banks’ exposure to credit risk, it does not imply that the headline measure of total social financing growth fails to capture the full extent of credit expansion to households and non-financial enterprises. “Shadow” lending by non-bank financial intermediaries is already covered by this measure. The increase in bank investments in such intermediaries, therefore, represents previous shadow lending being transferred onto banks’ balance sheets, rather than an unrecorded new credit.
The rise in holdings of debt receivables appears to account for most but not all of the rise in bank credit to the financial sector. The FT article stated that total debt receivables grew by 63% to RMB 14 trillion last year, implying an increase of RMB 5.4 trillion. Bank credit to other financial enterprises, however, expanded by RMB 6.4 trillion during 2015.
It is likely that official efforts to support the stock market have also contributed to the rise in bank credit to the financial sector over the past year. More recently, banks may have been lending to finance speculation in bond and commodity markets.
1) Credit expansion to households and non-financial enterprises is moderate by the standards of recent years. The total social financing measure captures “shadow” lending, including lending by banks channelled through “debt receivables”.
2) Total bank credit growth has been boosted by fiscal expansion and, probably, the local government debt swap programme (assuming that part of the money raised by new bond issuance has yet to be used to repay previous debt).
3) It has also been boosted by the transfer of shadow system lending onto banks’ balance sheets. This arguably makes explicit an existing credit risk, rather than creating a new one.
Recent credit developments, therefore, are nuanced and the simplistic claim that a generalised boom is in full swing and will inevitably lead to a bust should be discounted.
The forecasting approach here uses narrow money trends to assess economic prospects. Six-month growth of real (i.e. inflation-adjusted) narrow money, as measured by “true” M1*, rose strongly from mid-2015 into January 2016 but fell back in February / March – second chart. The earlier strength suggests a recovery in economic growth through the late summer, at least. Narrow money trends would need to weaken significantly further to warrant a shift towards pessimism.
*”True” M1 = currency in circulation plus demand / temporary deposits of households and corporations. The official M1 measure excludes household deposits.
Narrow money trends last summer signalled that the US economy would be weak in late 2015 / early 2016 while the Eurozone and UK would grow solidly. The latest GDP numbers are consistent with this forecast. Monetary trends continue to give a positive message for Eurozone / UK economic prospects and suggest that US growth will revive during the second half.
The quarterly rise in GDP in the first quarter was 0.6% in the Eurozone, 0.4% in the UK (0.44% excluding oil and gas extraction) and only 0.1% in the US. Over the fourth and first quarters combined, GDP grew by 0.9% in the Eurozone, 1.0% in the UK (1.1% ex oil and gas) and 0.5% in the US.
The first chart shows six-month growth rates of real (i.e. inflation-adjusted) narrow money. Growth in the US was well below that in the Eurozone and UK between June 2015 and March 2016. Weekly US data indicate a marked improvement in April – the final US data point in the chart is an April estimate. Assuming that this pick-up is confirmed, the suggestion is that US GDP growth will catch up with European performance.
Hopes of a significant US bounce-back in the second quarter, however, may be disappointed. US six-month real narrow money growth bottomed in October and monetary trends typically lead economic activity by about nine months. Real money growth, moreover, remained weak until recently.
An additional near-term concern is that US firms have made less progress with inventory adjustment than expected. Stockbuilding has fallen for three successive quarters but still amounted to 0.4% of GDP in the first quarter. With spending on goods contracting last quarter, the ratio of real inventories to final demand for goods and structures rose further – second chart. The stocks cycle, therefore, is likely to remain a drag on growth into the summer, at least.
The Eurozone and UK released money and credit data for March this week. Trends remain solid in both cases. In the UK, annual growth of narrow money, as measured by non-financial M1*, was 8.3% in March, up from 7.5% a year ago. Growth of the broader non-financial M4 measure rose further to 6.3%, the fastest since June 2008. The Bank of England’s preferred broad measure, M4ex, expanded by a smaller 4.8% in the latest 12 months but has been depressed by a fall in financial sector deposits, which are of less relevance for assessing near-term economic prospects – third chart.
Annual growth of private sector credit, as measured by M4ex lending, surged to 5.2% in March, the fastest since March 2009. A near-term setback is possible, with recent credit expansion boosted by unusually high borrowing by fund managers and a bringing-forward of buy-to-let and second home purchases to avoid the recent stamp duty rise.
The juxtaposition of consensus gloom about UK economic prospects with strengthening monetary trends is reminiscent of late 2012 / early 2013, ahead of surprisingly robust GDP expansion.
Annual growth of non-financial M1 in the Eurozone remains higher than in the UK, at 9.8% in March, while broad money growth is similar and credit expansion weaker – fourth chart. The ECB bank lending survey, however, continues to show a large majority of banks expecting stronger credit demand, suggesting a further recovery in loan growth – fifth chart.
*Non-financial = held by households and non-financial corporations.
UK slowdown talk is overblown. GDP rose by 0.4% in the first quarter, down from 0.6% in the fourth quarter of 2015, according to the Office for National Statistics preliminary estimate. Excluding oil and gas extraction, however, the increase was 0.44%. The average revision to the preliminary growth estimate since 2005, meanwhile, has been +0.07 percentage points. Adjusting for this bias suggests that the onshore economy grew by a respectable 0.5% last quarter.
The preference here is to monitor growth in economic statistics over two quarters / six months, on the view that this improves the signal to noise ratio relative to shorter-term comparisons. Two-quarter growth of gross value added excluding oil and gas rose from 0.8% in the third quarter of 2015 to 1.0% in the fourth quarter and 1.1% in the first quarter, according to current data. The onshore economy, in other words, has gained momentum. This pick-up is consistent with a rising trend in six-month real narrow money growth since late 2014 – see first chart. (March monetary statistics will be released on Friday.)
No demand breakdown of GDP is yet available for the first quarter so it is not possible to evaluate the Bremain camp claim that referendum-related uncertainty is depressing business investment. This claim, however, is contradicted by the April CBI quarterly industrial trends survey released earlier this week: an average of the net percentages of firms planning to increase spending on plant / machinery and buildings rose to its highest level since 1997 – second chart.
Recent better Chinese economic data, and an associated rebound in China investment plays, were signalled by a pick-up in monetary growth in the second half of 2015. Pessimists, however, argue that economic recovery is based on unsustainable policies and will fizzle in the second half of 2016. Monetary trends have cooled since the start of 2016 but would need to weaken significantly further to support the pessimistic case.
The first chart shows six-month growth rates of industrial output and narrow money deflated by consumer prices. The narrow money measure used is “true” M1, comprising currency in circulation and demand / temporary deposits of households and non-financial enterprises. This is superior conceptually and in terms of historical forecasting performance to the official M1 measure, which excludes household deposits. Such deposits, clearly, are relevant for assessing consumer spending prospects.
Real narrow money contracted in late 2014, warning of economic weakness in 2015. Growth resumed early last year and surged from the summer. It peaked in January 2016, falling back in March to its lowest since August.
This turnaround is confirmed by broader aggregates. The preferred broad measure here is M2 excluding financial deposits, which are less likely to have signalling value about economic prospects. Such deposits grew strongly in 2014-15, inflating the headline M2 measure, but have slowed recently. Six-month growth of real M2 excluding financial deposits also fell notably in February / March – second chart.
The reversal in real money growth follows a period of significant strength and is judged here to be insufficient in terms of magnitude and duration to warrant shifting back to a negative view of economic prospects.
Monetary trends typically lead economic activity by about nine months. Even if the January real money growth peak is confirmed, the suggestion is that economic momentum will continue to rise into October 2016.
The March level of six-month real narrow money growth, moreover, remains robust by historical standards, at more than 7%, or 15% at an annualised rate. The slowdown to date, in other words, is consistent with a moderation of economic expansion, not weakness.
A further point is that the fall in real narrow and broad money growth partly reflects a sharp rise in six-month consumer price inflation, due to stronger food prices. A recovery, therefore, is possible as the food price effect fades or reverses.
Finally, pessimists may be neglecting additional economic stimulus from recent exchange rate depreciation. The China Foreign Exchange Trade System (CFETS) RMB index against a basket of trade-partner currencies has fallen by 8% from a peak in August 2015, equivalent to an annualised rate of decline of 11% – third chart. The pessimists, ironically, were correct to expect the authorities to engineer a weaker currency but underestimated their ability to achieve this, with the Fed’s help, without negative financial / economic consequences.