China Industrial Profits Rise

China Industrial Profits Rise

China’s major industrial firms saw stronger profit growth in the first ten months of this year, the National Bureau of Statistics(NBS) said Monday.

China’s industrial sector has been boosted by a year-long, government-led construction spree, which helped lift demand and prices for building materials, especially over the first half of the year.

Prices of industrial commodities have also been resilient despite a tightening in financial markets, as closure of polluting plants and factories have fueled fears of supply shortages in the winter, lifting prices of finished goods including steel and copper products.

The companies reported a 23.3 percent year-on-year profit increase in the ten-month period, up from 22.8 percent in the first three quarters, the NBS said in a statement.

In October alone, profits of major industrial firms rose 25.1 percent year on year, it said.

More than half of the increase in profits in October came from mining, iron and steel smelting and processing, chemicals, and oil and natural gas extraction.

Mining industry profits soared 405.4 percent from a year earlier in January-October while manufacturing profits were up 20.1 percent.

Profits earned by China’s state-owned firms rose 48.7 percent to 1.41 trillion yuan in the first 10 months, picking up from a 47.6 percent increase in January-September.

ASEAN’s growth continues to fuel the demand for commodities. Two of our HSBC economists – Douglas Lippoldt and Paul Bloxham shared their insights on the latest commodities trends at the recent HSBC Commodities Industry Leadership Forum in Singapore.

While the market debates China’s latest round of economic growth, national regulators are focusing on an equally important factor of the economy: financial cycles.

In its latest quarterly monetary policy implementation report, the People’s Bank of China (PBOC) devoted a special column to this concept, describing it as an “increasingly significant issue” that should be dealt with macro-prudential approaches to prevent systemic risks.

“While traditional monetary policy can address instability during economic cycles, it is not effective enough to balance controls on economic cycles and financial ones, which are caused by the expansion and contraction of financial variables,” the central bank said.

The global financial crisis showed that traditional economic indicators, like GDP growth and the inflation rate, were not necessarily linked with financial stability.

Before the U.S. subprime mortgage crisis in 2007, though the global economy was on a strong rise with steady inflation, skyrocketing stock markets and house prices sowed the seeds of the crisis.

“When economic and financial cycles do not move in sync, they may lead to different or even adverse effects, thus making macro-policies conflicting and ineffective,” the PBOC report said.

The central bank’s concern is in line with many other governments and international institutions, who warn that the ups and downs of financial cycles may span economic ones, and could even lead to a future crisis.

In its annual report earlier this year, the Bank of International Settlements (BIS) noted the looming risks triggered by financial expansion in several countries, saying “the main cause of the next recession will perhaps resemble more closely that of the latest one — a financial cycle bust.”

The issue is particularly relevant in China today as the country is working on a deleveraging process, while putting tough curbs on the property market to defuse risks and asset bubbles, both considered key indicators of financial cycles.

“The impact of financial cycles on the macro-economy is not short-term fluctuations, but rather mid-term ones,” said Peng Wensheng, global chief economist with Everbright Securities, stressing the “pro-cyclicality,” or self-reinforcing nature of both bank credit and property prices.

To better harness financial cycles, the PBOC, like many other central banks, has adopted a policy framework that involves the use of both monetary tools and macro-prudential regulation to make counter-cyclical adjustments.

Under a “twin pillar” framework, the central bank has established a macro-prudential assessment framework to regulate financial institutions, and increasingly relied on monetary tools, like open market operations for liquidity management, rather than adjustments in interest rates or reserve requirement ratios.

The twin pillar framework was emphasized in the key report delivered to the 19th National Congress of the Communist Party of China, which reiterated efforts to improve the financial regulatory system to forestall systemic financial risks.

China’s overall leverage ratio is still growing, but at a slower pace. Overall leverage was 257.8 percent of GDP at the end of the first quarter of 2017, slightly up from 257 percent at the end of 2016. The non-financial corporate leverage ratio declined to 165.3 percent at the end of March from 166.3 percent at the end of 2016, according to BIS.

The government has also stepped up scrutiny to stem malpractice in the financial sector, as well as placing strict controls on the real estate market to curb speculation.

“Deleveraging is a slow and complicated process, and the permanent cure to high leverage risks is solving structural issues,” said Zhou Yueqiu, director of the Urban Finance Research Institute of Industrial and Commercial Bank of China.

Peng also said that although the possibility of China seeing a systemic financial crisis was small, it did not mean that the real estate and financial sectors should seek unlimited expansion.

“To make further financial structural adjustment, China should increase the use of fiscal tools in the money supply instead of only relying on bank credit. Meanwhile, the government should strengthen its ongoing regulatory scrutiny to curb misconduct in the sector,” Peng said.

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S. Jack Heffernan Ph.D. Funds Manager at HEFFX holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b. He has managed and overseen start ups in Mining, Shipping, Technology and Financial Services.

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