Feature Stories | Jul 29 2013
This story was first published for subscribers on July 16. It has now been opened to general readership.
– Chinese GDP data indicates slowing
– Beijing hellbent on pursuing reforms
– Lower growth rate a consequence
– Analysts concerned policy may backfire
By Greg Peel
China’s official June quarter GDP result released yesterday showed year on year growth of 7.5%, down from 7.7% in the March quarter. Official releases from Beijing are always taken with a grain of salt by the rest of the world, given Beijing’s miraculous efforts in producing GDP data only two weeks following the quarter close. Developed economies of much lower populations take around three months to reach final numbers. Recently Beijing decided to temporarily suspend purchasing managers’ index (PMI) releases on the basis the data was becoming “too hard to collect”. GDP results are far more complex than PMIs.
But it’s all we’ve got, aside from attempts by non-Chinese economists to estimate China’s GDP based on other factors such as import data from China’s customers and China’s own electricity consumption levels, which in the past have been considered a reasonable proxy for economic performance (although are often themselves under question).
ANZ Bank notes June quarter growth in China was mostly dragged down by declining industrial production, which grew by 8.9% year on year in the month of June compared with 9.2% in May, and exports, which fell in May by 3.1%. Anecdotally, ANZ is not alone in assuming the poorly handled short term credit squeeze last month was a contributing factor.
The renminbi has been rising steadily in value for some time under Beijing’s watch to address perceived significant undervaluation to the US dollar against which China’s currency is pegged in a range. As has been the case for Australian exporters, the rising currency has reduced China’s trade competitiveness at a time when Japanese monetary policy has substantially devalued the yen and a weak European economy is keeping the euro in check. This loss in competitiveness will remain a headwind going forward, suggests ANZ.
Further downside risk is offered by the fallout from the credit squeeze which should see finance becoming more expensive and more difficult for small and medium enterprises (SME) to acquire, notwithstanding the attack on shadow banking which will reduce speculative investment. Unemployment is now also becoming an issue, in a country of 1.2 billion, given the aforementioned loss of trade competitiveness and a record number of university graduates set to hit the jobs market this year.
ANZ believes Beijing’s policy must change to reflect the changing conditions, and notes a rate cut is “long overdue”. The risk of fresh monetary stimulus finding its way only into further speculation in property and wealth management is not such a concern given the scope for investment in urban infrastructure, technology upgrades and human capital, say the economists.
ANZ suggests such policy action should see China book 7.6% GDP growth for 2013.
Beijing’s target for 2013 is 7.5%. There was some consternation when the Chinese finance minister either innocently erred or let slip a policy blooper on Friday last when he suggested GDP would likely average 7.0% this year. That “error” was quickly cleared up by the Chinese newsagency. Earlier in the week Premier Li Keqiang defended China’s falling growth rate (2012’s 7.8% GDP growth was the lowest in 13 years) and Beijing’s lack of a monetary policy reaction, insisting the government will continue with the structural reforms, which have crimped growth, and create fresh growth engines. “Only economic transformation and upgrading can support sustainable and healthy development,” he said.
Nobody much disagrees. Ever since Beijing introduced the world’s biggest fiscal stimulus package in late 2008 and backed that up with monetary easing the world has been concerned over bubbles in China’s property market and credit markets, with local government debt of a particular issue. Monetary policy has since been tightened and eased as conditions required but the new regime now in place in Beijing has not acted as it was assumed by most — that is to loosen monetary policy in the face of slowing growth. Despite attempts to pump up China’s domestic economy, GDP growth is still very much dependent on exports and Europe and the US are China’s biggest customers. The US economy is recovering, tenuously, while Europe will likely remain in the doldrums for some time.
Sustainable and healthy development in China is everyone’s panacea, but the issue is as to whether Beijing can actually achieve what is a very fine balancing act. No one argues that structural reforms, such as measures to fight pollution, corruption, currency speculation and shadow banking, are a necessity if China is truly to move into the modern financial world and avoid the bubble-bust cycles of earlier decades. But everyone is sheepishly asking, “Do you have to do that right now? And all at once?”
Beijing is forcing through its reforms at the same time its economy is slowing, both from internal and external factors. The government has suggested it will place a “floor” under GDP growth, such that fresh policy would be enacted if the economy slowed too far, but according to the finance minister, growth of 6.5-7.0% would not be “a big problem”.
Overcapacity, unsustainable local debt and credit dislocation have spooked equity investors, notes Citi’s Asia team. No more so has this been evident than in Australia these past couple of months. By the time China’s September quarter GDP is released in October, Beijing’s policy moves will be under close global scrutiny. If June has seen a drop to 7.5% from 7.7% in March, and risks remain to the downside, the 7.5% “target” for 2013 is unlikely to be achieved. But then the government is attempting to sound circumspect. Citi believes the Chinese economy may indeed test 7.0% growth over the next twelve months if the clampdown on shadow banking forces China to start deleveraging.
“Investment slowdown and local government defaults are major risks alongside possible deleveraging,” says Citi. “Global trends suggest that the investment growth rate could halve once the investment-to-GDP ratio peaks. China may be near that tipping point”.
In 2011, China was struggling under a too-high CPI inflation rate. Much had to do with food price spikes, but tighter policy began to bring underlying inflation down, from over 6% to near 2% earlier in 2013. At 2.7% in June, China’s CPI is well under Beijing’s 3.5% target. However the June result showed a bounce from May’s 2.1% (year on year). Inflation is now expected to gradually trend back up again which may yet preclude fresh policy loosening even if GDP slows too fast, Citi warns.
CIMB’s analysts are not wildly concerned over the shadow banking clampdown. While liquidity tightness will choke off funding and raise the cost of debt the ultimate impact on GDP is likely to be limited, they suggest, as significant amounts of credit have been going to unproductive sources. But they also note China’s equity market is disproportionately weighted towards upstream state-owned enterprises that consume a disproportionate amount of the country’s credit. While greater efficiency in the allocation of credit is part of Beijing’s reform agenda, until a new equilibrium is established there is a rising risk that profit share could continue to disappoint, says CIMB. Eventually SMEs should not only comprise a bigger share of the market, but also should be more profitable, the analysts suggest. But only over time.
That said, BA-Merrill Lynch notes Chinese industrial earnings growth is pointing to “an early stage of a weak recovery”. The most recent data showed growth accelerated to 15.5% (year on year) in May from 9.3% in April, albeit off a low 2012 base. Downstream sectors are seeing their earnings continue to improve, says Merrills, with early-cycle sectors such as auto and electronic manufacturing leading the charge. The same positive signal is yet to reach the upstream sectors nevertheless, which keep losing money on falling commodity prices.
Merrills is currently forecasting Chinese GDP growth of 7.6% for 2013, and for 2014, with quarterly results of 7.7%, 7.6% and 7.6% for the June, September and December quarters of 2013 respectively. Merrills’ forecasts were set prior to Monday’s 7.5% result for June, but earlier this month the analysts conceded “more downside risks than before”. Having said that, they also believe an expected deleveraging from small Chinese banks as a result of the forced credit squeeze will have limited impact on system-wide credit supply given the big banks can fill the gap.
Citi has downgraded its GDP forecasts to 7.4% for 2013 and 7.1% for 2014, suggesting the chance of government stimulus at this point is remote. Yet Citi is not unhappy with Beijing’s tactics, believing the government’s emphasis on reforms “may bring short term pain before reaping long term gain”.
On the other hand, Citi’s discussions with government think tanks suggest a quarterly growth number below 7.0% year on year is “not acceptable”. Were growth to slow this far, the analysts believe some policy response is possible, in the form of a rate cut, currency depreciation or reduction in the bank reserve requirement ratio (RRR). The ultimate determinant for Beijing will be stable employment, they say, and while no reliable jobless data are collated by the government, the employment component of the PMI does provide an early warning. Beijing has temporarily suspended the publication of PMIs but presumably the data will still be collected and considered by the government.
Were a policy response to be required, investment will be directed away from speculation and towards urbanisation, such as subways, water treatment and social housing, and areas that may help promote consumption, such as medical facilities, tourism, culture and entertainment, Citi suggests.
It’s all well and good, but a less optimistic Merrills points out that previous rounds of government pro-growth policies have not worked in the long run and if anything could make things worse. Given the current instability of the economy, featuring high exposure to investment and property and an unstable financial market, the Merrills analysts are no Pollyannas. “We think the chances are high,” they lament, “that something somewhere somehow will go wrong, potentially causing a growth and market shock”. The Chinese government, Merrills warns, does not always get what it wants.
The Macquarie team is not waving any Black Swan flags a la Merrills, but nevertheless feels the structural reforms aimed at solving China’s ingrained problems may lead to even slower growth. Macquarie has lowered its GDP forecasts to 7.3% for 2013, down from 7.8%, and to 6.9% for 2014, down from 7.5%. If Macquarie’s forecasts prove accurate, Beijing may not deem a policy response to be required until well into next year.
Which raises the issue of what actually could go very wrong in the meantime. One longstanding rest-of-world fear over China’s tenuous economy is that of the famed “ghost cities” – massive, gleaming new apartment block complexes in regional areas which the local simply cannot afford to live in. With speculation fuelled on shadow credit suggesting a property bubble in the big cities, empty housing elsewhere threatens a serious property market collapse.
Blackstone’s Byron Wien spent time in China in June to gain a perspective at ground level, and does not believe the so-called ghost cities are an issue. Fears have been lingering for several years now, yet no property collapse has been forthcoming. A recent survey of prices for residential real estate in 100 major Chinese cities shows a clear uptrend, Wien points out.
The Macquarie analysts are also dismissive of ghost city paranoia. One or two ghost cities are not sufficient to cause oversupply across China, they entreat. There is a shortage of housing supply in the tier one cities which will unlikely be resolved in the near future. The shortage will likely spread to tier two cities within three years, Macquarie suggests, leaving small city oversupply to continue unless stimulus is introduced.
Another factor with the potential to relieve property pressure is that of “Hukou” reform. In June the government announced a gradual relaxation of restrictions on citizen registration for non-residents of China’s towns and cities. “Non-resident” does not imply foreign migrants, merely domestic regional migrants. Beijing has over recent years tried to prevent a rush of regional and rural workers looking for work in the big cities, lest the big cities become too rapidly oversupplied with labour and rural areas simultaneously die from lack of labour.
The government’s controlled urbanisation plan has now moved to the point citizen registration will be opened up initially for non-residents in smaller towns and cities, with larger cities gradually relaxing controls as well. Citi believes “migrant” workers will be the key to the urbanisation process, and that the relaxing of citizen restrictions will be positive for market sentiment.
Blackstone’s Byron Wien believes the real risk China faces is not a property bubble, but that of non-performing loans at China’s banks and “shadow banks”. For a long time the Chinese central bank has been willing to provide sufficient liquidity to keep banks functioning, despite what is assumed from outside to be a significant level of loans in default. The People’s Bank of China has now taken steps to clamp down on irresponsible lending, but a question is thus raised: Can China’s economy continue to grow at high single-digits without the easy credit which has been flowing since 2008?
The other issue Wien perceives centres around Beijing’s attempts to swing the Chinese economy from being export-reliant, and thus beholden to slow economies outside China, towards being domestically-focused, drawing upon the consumer capacity of China’s huge population. Basically, you can lead a horse to water but you can’t make it drink.
In 1999, notes Wien, the consumer component of Chinese GDP was 46%. By 2010 the proportion had fallen to 35%, with investment spending growing to represent 45%. The government’s last “five year plan”, released in 2010, included a goal of bringing consumer spending back to 45% of GDP, but little progress has been made to date.
“There are plenty of goods on the shelves of stores, but Chinese consumers seem reluctant to spend,” says Wien. “Older people save for their retirement and healthcare expenses and younger families save for the education of their children and to buy a house or apartment. Incentives may have to be provided to stimulate consumption. If the economy is not rebalanced China will have to continue to rely on exports for growth. With Europe still in a recession, the US growing at 2% and most of the developing world slowing, exports may continue to be disappointing. China’s new leaders have said they are focused on implementing reforms. Achieving a high level of growth is not their primary goal.”
And therein lies the crux. The US is keeping a wary eye on the Chinese economy, but is now far more inwardly focused on a central bank-supported, domestically-driven recovery. Europe and Japan are major exporters, hence a slowing in China can provide some local impetus as both economies attempt to drag themselves out of the mire. For Australia, the issue of a slower China is far more dire.
Spending on mining in Australia has now peaked and the industry has shifted into a production, or volume, phase. Meanwhile the non-mining economy remains stubbornly subdued despite easing efforts from the Reserve Bank. In order to provide for a smooth transition away from a resource sector focus and towards a more even spread of sector contribution, the Australian economy would really like China to continue buying iron oil, coal, copper, gas and so forth at least at a rate which will comfortably soak up new supply, if not at growth bubble pace. Such a plan is threatened, and thus an Australian recession a threat, if China slows too fast and Beijing does not respond.
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