China's economic challenges: Rate cuts, weak indicators, and currency pressures

By Samir El Khoury, ACSI, ACICMP?

This week, the People's Bank of China abruptly cut the one-year lending rate by 15 basis points to 2.50%. This is the largest cut since 2020 and came unexpectedly in terms of timing and the size of the cut, as expectations were that the People's Bank of China would reduce the interest on lending for one year by 10 basis points in September 2023.

The Chinese central bank also lowered the 7-day reverse repo rate (REPO) by 10 basis points, to 1.80%.

This precautionary move by the People's Bank of China seems natural and logical, especially when considering the Chinese economic data, which still shows weakness in the performance of the Chinese economy. The economy has not been able to recover since China lifted the strict epidemic measures in December of last year.

On Tuesday, the results of retail sales, industrial production, and investment in fixed assets were lower than expected. Additionally, the unemployment rate rose to 5.3%, higher than the previous reading of 5.2%.

For the first time since 2020, both the consumer price index (-0.3%) and producer prices (-4.4%) contracted on an annual basis in July of this year. This indicates persistent deflationary pressures and weak demand.

Regarding trade figures in China, exports declined for the third consecutive month by 14.5% in July, marking the largest decline since February 2020. Imports also decreased for the fifth straight month by 12.4%, suggesting ongoing weakness in global demand and particularly weak demand in China.

In a surprising move, China announced that it will temporarily stop publishing data on the unemployment rate among youth, which recorded 21.8% in June, due to improvements in labor statistics.

Turning to the real estate sector, it is facing significant pressures, especially with the failure of "Country Garden" to pay returns worth $22 million and the suspension of trading on 11 of its bonds earlier this week. As a result, the value of its bonds has declined by 90% since the beginning of 2023.

It's worth noting that the cash flow rates of real estate companies in China fell to historical lows in the first half of this year. The rate of return on free cash flows of real estate companies dropped to 133%. The most concerning aspect of this situation is the potential negative effects of a domino effect on the real estate sector, which could impact related sectors, especially the credit market and the Chinese banking sector that largely finances the real estate industry. ZHONGRONG, worth $2.9 trillion in China, has defaulted on payments for 10 of its products.

Due to the factors mentioned above, the Chinese Yuan is under selling pressure, despite the intervention of the People's Bank of China to stabilize the exchange rate of the US dollar against the Yuan daily over the past months.

Yesterday, the exchange rate of the US dollar against the yuan in offshore trading recorded 7.3497. This is its highest level since November 3, 2022, and it is currently trading within the range of 7.2825 - 7.3085.

From a technical perspective, there is a golden cross between the 50-day moving average in blue and the 200-day moving average in yellow. This suggests that the exchange rate of the US dollar against the yuan is on the verge of further increases, indicating potential further deterioration of the Chinese currency in the upcoming period.

Regarding the RSI (Relative Strength Index), it is nearing the overbought area.

Please note that this analysis is provided for informational purposes only and should not be considered as investment advice.

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