Investors are turning cautiously optimistic on China’s growth outlook amid the latest easing measures in January. There is still little awareness about the rising deflation risk.
It was quite a surprise to discover that only a handful of investors were aware of the rising deflation risk in China. In the past 10 years, PPI has been a reliable gauge of the economic cycle. As falling producer prices drive down industrial utilization, profit growth will slow as China enters a new cycle of corporate revenue growth. Lower PPI also means lower nominal GDP growth. In our view, market concern about corporate debt repayment will resurface when nominal GDP growth falls below 8% and more corporate debt defaults will start to accumulate when that indicator falls below 7%. This is because 7% nominal corporate revenue growth will not be enough to cover nominal interest rate payment so that outstanding corporate debt can be rolled over. We expect nominal GDP growth to rapidly decelerate to ~8% owing to PPI deflation in H1/19. In addition, domestic PPI deflation led by both primary goods and final manufactured goods could lead to the mainland exporting deflation to the rest of the world. Overall, we think investors have not paid enough attention to the emerging deflationary pressure in China.
Chinese nominal growth fell below 8%, to 7.8%, in Q1. PPI turned negative in the July data.