The four aspects of China’s big picture:
From a cyclical perspective, Bridgewater Associates’ Ray Dalio sees overall levels of activity in China (FXI) (YINN) as “neither too high nor too low.” Growth has accelerated, is strong, and is hitting its full potential. Potential output is broadly at the maximum that an economy can sustain over the medium to long term without stoking inflation. Dalio also sees the GDP gap – the difference between actual GDP and potential GDP – at equilibrium. This implies that China is currently operating at its full potential.
Inflation in the economy, which is to a good extent, driven by the pace of economic activity and rise in consumerism, has also picked up. While it currently remains modest at 1.2% (as of April 2017). Core inflation, which excludes volatile food and energy prices, has picked up particularly well. It stood at 2.1% in April 2017. It was at around the 1.6% level in mid-2016.
Debt remains high (and a key concern) in China (YANG) (FXP) (CHAD), growing 300% faster than the economy. Short seller Jim Chanos has noted that China’s financial system has fallen prey to Ponzi finance where a lot of loans in China are simply new loans issued to keep the old loans current. The IMF has repeatedly been issuing debt warnings to China, and the economy is now trying to maintain amidst rating downgrades.
4. Interest rates
Interest rates in China have been declining/low over the recent past. Since 2012, the benchmark rate in China has been declining. Since last year, the short-term lending rate in China has remained below 4.5%. On March 16th, 2017, the People’s Bank of China raised the interest rate it charges on short-term open-market operations by 10 basis points due to strengthening market expectations for higher funding costs in light of rising domestic inflation and property prices.
Moreover, the interbank lending rate has remained low through 2016. In 2017, however, we’re seeing sudden spikes in the rate, which Kyle Bass sees as evidence of China beginning to unravel. “When an economy is at max leverage supported by interbank funding, you see sudden spikes in the interbank rate every now and then,” said Bass.