Research and analysis

China economy: risks rising, analysts divided, leadership resolute

Published 1 June 2014

0.1 Detail

Latest data show the economy continues to slow, with growth in both fixed asset investment and industrial production edging down. Absent policy stimulus, 2014 Q2 GDP growth will likely fall below the 7.4 per cent year-on-year growth registered in 2014 Q1 GDP. The authorities’ growth target for this year is ‘around 7.5 per cent’.

The slowdown is caused by declining credit growth. Total social financing, a broad measure of credit, expanded by 16 per cent year-on-year in April, the lowest rate of growth for around 10 years, (but still significantly above GDP growth, meaning China’s debt ratio continues to rise).

The property sector shows the greatest strain, with supply-side indicators like property investment growth and floor-space starts falling quite fast. Demand side indicators like sales’ volumes and prices are also starting to wobble.

Analysts are divided on what will happen next. The more bearish commentators, for example, The Conference Board or Wigram Capital, foresee a serious fall in output in the next 18 months, precipitated by a sizeable correction in the housing market.

Others, for example Capital Economics or Standard Chartered Bank, agree that China faces a period of painful adjustment but the slow-down will be more gradual. They take comfort from more positive indicators, like generally robust corporate profits, a tight (and apparently tightening) labour market, stable inflation and decent growth in exports.

There is general agreement around two points. First, the current Chinese leadership is showing resolution in the face of the slow-down. Recent examples:

• on 12 May, President Xi said that China needed to adapt to a ‘new normal’ of slower growth and that the country faced ‘a significant period of strategic opportunity’ to press ahead with reform. This tallies with consistent messaging from senior policymakers since last November’s 3rd Plenum that the growth target is no longer totemic. Provided other indicators remain stable, in particular inflation and employment, growth would be allowed to dip below the target; and:
• on 14 May the weekly executive meeting of the State Council chaired by Premier Li focused on long-term reforms to the service sector. Outside observers point to the progress Li has made since the Third Plenum in implementing reforms, including significant measures to support service sector development.

Second, the adjustment is essential if China is to both avoid larger problems down the road. China’s structural imbalances have built-up over time. Loose credit has allowed significant over-capacity to emerge in some sectors, like property, steel, cement and shipbuilding. However, even those analysts that foresee serious difficulties in the coming 18 months also believe that, assuming the leadership remain focused on reform, the Chinese economy will emerge stronger and more dynamic in the medium term.

Some judge that the risks have increased in recent months. The property slow-down has been sharper than expected. However, a precipitous decline in overall output seems unlikely. This doesn’t mean that further short-term stimulus won’t be introduced to stabilise growth. Most analysts are predicting 100-200bps cuts to banks’ required reserve ratio, either during 2014 Q2 or Q3. But it does suggest that any such measures will go alongside (rather than at the expense of) longer term reforms – both walking and chewing gum.

If the adjustment happens too fast, for example if full-year growth looks like falling significantly below expectations, the authorities have policy space, including accelerating existing plans for public infrastructure investment and freeing up more lending. And China is effectively insured against serious instability through its $4trn reserves, capital controls and vast state assets.

Under either scenario there is the risk of greater volatility in coming months, with more defaults and bankruptcies in those parts of the economy plagued by overcapacity.

0.2 Disclaimer

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