China economy improves in second quarter but deleveraging poses risks: private survey

Illustration photo of a China yuan note

BEIJING (Reuters) – China’s economy continued to improve in the second quarter, with corporate profits rising and hiring up, a private survey showed, but it suggested the Asian giant may have to brace for tougher times ahead even though firms have been able to weather a tighter financing environment.

The quarterly survey of thousands of Chinese firms by China Beige Book International (CBB) showed that while the property sector slowed, manufacturing improved further and the retail and services industries bounced back after a difficult first quarter.

That reinforced a flurry of recent data and policy makers’ comments that indicated authorities were working to curb financial risks and keep the economy on an even keel heading into a key political meeting this year.

The survey showed surprisingly strong performance in the commodities sector despite some price weakness in the second quarter, with the aluminium sector particularly strong.

The improving economy, especially the healthy labour market, is no doubt welcome news ahead of a leadership revamp at an autumn congress of the ruling Communist Party of China.

Yet signs of stress in the corporate sector pointed to a bumpy ride for businesses. CBB said cash flow was negative for many companies and inventory levels in the second quarter was at the highest in the history of the survey.

That is in line with official data showing growth in industrial inventories picked up to over 10 percent in April, sparking worries of weak demand.

CBB said there are signs tougher times could be ahead for Chinese companies during a period of deleveraging and rising interest rates.

“It remains true that either rates have to come plunging back down, as the (state planner) recently called for, or the present level of corporate activity is headed for a cliff,” CBB said in its report.

As the government stepped up its campaign to curb debt risks and stabilise the financial sector, growth of China’s broad money supply came in at the slowest in at least two decades in May, though bank lending remained solid.

The CBB survey showed the corporate sector started to feel the effect of tighter credit conditions in the second quarter after escaping relatively unscathed in the first three months of the year, with the cost to take a bank loan the highest since 2014.

But borrowing was not impacted much, CBB said, likely due to firms’ positive business outlook for the next six months, though CBB said that this may not last if tightening persists.

“Companies assume deleveraging is transient, likely because they are skeptical the Party will allow economic pain in 2017. It will not be until 2018 when we find out whether deleveraging is genuine—because it won’t be until 2018 that it will actually hurt”, CBB said.

(Reporting by Elias Glenn; Editing by Shri Navaratnam)