Short Thoughts on China's March Trade Disaster

China’s March trade data looks nothing short of disastrous.  In particular, the 15% yoy fall in exports is a dreadful shock, with the US$144.57bn in exports the lowest nominal total since February 2014’;s holiday-afflicted tally. Worse, March is usually a strong month for exporters, with the history of the last five years showing an average rise of 40.1% mom: this year, exports fell 14.6% mom. In terms of standard deviations from the pattern, February;’s total was 1.6SDs above trend, but March’s was 6.7SDs below trend.

Such a collapse can’t really be described as a ‘deviation against the trend’, but rather a result which smashes the historic trend entirely - China has entered new and dangerous waters.  As such, it has implications both for China and its trading partners.

Before we consider that, however, there is another possibility - that the very smashing of normal seasonal patterns points to some sort of seasonal anomaly which we don’t yet understand and which is afflicting only exports. If so, we should ignore this monthly collapse in preference to the slightly longer-term picture.  Doing so allows one to see that during 1Q exports rose 4.6% yoy, which, although not great, is roughly in line with the 6% yoy growth recorded in calendar 2014.

And there is a second lifeline to this less-pessimistic approach: although March’s imports fell 12.9% yoy, the monthly move (a 30.3% mom rise) conformed almost exactly to historic seasonal patterns, after 1SD+ falls in both January and February. Although with the exception of petroleum and refined products, there is no sign of a recovery in China’s appetite for industrial commodities,  volumes of commodity imports have generally stabilised.

Hang onto that hope, because, having acknowledged those qualifications, March’s collapse of exports, and the consequent collapse of the trade surplus (to just US$3.1bn in March from Eu60.62bn in February), are the last thing China needs. There are two interlinked problems. First, China needs a hefty trade surplus to counter enormous underlying cash outflows which are undermining the liquidity of its financial system. Let’s do the maths: during 4Q14 China had a current account surplus of US$67.021bn, but its foreign exchange reserves fell by US$44.68bn - so somehow there was a net capital outflow of US$111.7bn in 4Q alone.  Second, this capital outflow put pressure on the banking system’s net cashflow: the private sector generated a net savings surplus of Rmb1.925tr in 4Q, equivalent to 8.9% of GDP. These surplus savings should have piled into the banking system as a build-up of net deposits: in fact, what happened during 4Q14 was that banks gave out Rmb 900bn more loans than they received in deposits.

That is the background to January’s expansion of the definition of ‘deposits’ counting towards regulatory loan/deposit ratios, the cuts in banks’ deposit reserve requirements announced in February, and, of course, the cuts in interest rates.

But there is a third problem: if the collapse in March’s export earnings and trade surplus are taken at face value, they also suggest that the loss of competitiveness may put the Rmb under pressure.  That is something I expect PBOC will be reluctant to entertain, simply because of the level of international debt China is now carrying. How much debt?  Last week fx regulator SAFE said those debt were ‘broadly under control’ at US$895.5bn at end-2014, of which US$621.1bn was short-term debt, and US$274.4bn was medium and long-term debt.  But it could be much more: according to BIS, at end-September 2014 (latest data available), their banks had extended US$1.3tr in debts to China, and in 4Q, BIS also reported private international debt securities outstanding to China to total US$91bn. If you are carrying that sort of debt-load, there’s plenty to lose from a currency devaluation. 

This is where things begin to matter, a lot, for China’s trading partners. Right now, most of Asia is living in a world in which although liquidity flows from the West to the East have lessened as the dollar has strengthened, thus discouraging growth-by-leverage, most companies have found compensation in a rise in the terms of trade.  So although in March, export prices were down 11.6% yoy in dollar terms for Japan, down 10.2% for S Korea and down 7.7% for Taiwan, in each case, import prices were down much further, so terms of trade were up 12.2% yoy for Japan, 9.7% yoy for S Korea and 9.6% yoy for Taiwan. The upshot is that the deflationary impact of a sharply rising dollar on profits and margins have been more than offset by falling import prices. 

Such a reasonably satisfactory outcome  for the rest of Asia would probably not survive a trading environment in which China was compelled to devalue sharply to recover export market share gains.