The market received China’s latest economic news with an audible sigh of relief. Growth has slowed but remains in line with expectations. Those expectations, however, have been difficult to gauge due to a number of factors.
Most obviously the
state media agency, Xinhua, reported last Friday that Finance Minister Lou
Jiwei had suggested 7% growth remained a viable target, but not a “bottom
line”, for 2013. With market consensus still hovering around 7.6% (down
from 8.1% as recently as April) this was something of a bombshell. Xinhua,
however, later corrected the article to show a target of 7.5% and removed the
reference to downside risks.
On Monday morning the
National Bureau of Statistics reported second quarter growth of 7.5%. That’s
the second slowest rate of growth the People’s Republic has reported since the
global financial crisis (it slowed to 7.4% in the third quarter of last year).
However, the more important point is whether this growth is unbalanced, and
whether it is driven by debt accumulation, monetary distortion and excess
The data accompanying
the GDP release have suggested that there is modest room for optimism.
Retail sales growth has been picking up lately but remains slower than recent
years. Industrial production growth has slowed. China has always
been the shining example of a gradualist approach to economic development, but
it has also been moving in a fairly straight line thus far. Like all
large and fast moving vessels, it will be difficult to change the Chinese
economy’s direction quickly.
As the economy
develops it becomes increasingly difficult to credibly change the
message. Urbanisation and industrial expansion have been the mantra for
two decades but with the average Chinese crowded out of urban property markets
by speculators, and pollution exposing the downside of rapid economic
investment, evidence suggests there is a degree of disillusionment amongst the
Examples of the
weakening ability of Chinese policymakers to impose direction on the economy
are easy to find. Last week, public protests led to a uranium processing
plant being cancelled. Paradoxically, nuclear energy would be one way of
assuaging Chinese concerns over pollution (although China is only targeting 6%
of total electricity production from this source by 2020). But, if such ‘not-in-my-back-yard’
protests were to become common, China’s potential struggle to replace polluting
coal-fired electricity production with cleaner energy may be just one headwind
are plenty more. The strength of public feeling building on environmental
factors may reflect the fact that pollution is a greater headwind for growth
than had been assumed.
authorities want to shift industrial capacity to commercial activities but
hopes of a seamless transition seem very optimistic to us. Trying to
expand consumption, or services, at a time when the People’s Bank of China is
already attempting to restrict the growth of the Chinese shadow banking system,
and the rampant Chinese property market, also looks like a tall order.
speculation is one of the explanations put forward for the first quarter rise
in fake invoicing. Fake invoicing is a fraudulent practice which occurs when an
exporter sells a bogus invoice to a speculator who is looking to circumvent
China’s fixed capital account.
fake invoice gives the exporter the opportunity to reclaim value added tax
(VAT). The net result is that speculative inflows are reclassified as
export revenues. An economy with robust exports should generally prompt a
strengthening currency, whereas an economy attracting net capital flow hints at
a depreciation waiting to happen. Fake invoicing is clearly just one
factor contributing to China’s current account surplus and rapid growth, but it
is one more factor which hints at a third quarter growth slowdown.
In July’s Bank of
America/Merrill Lynch Fund Manager Survey a hard landing in China is the factor
which most investors (56%) identified as the greatest tail-risk (a small
probability, high impact event) facing the global economy. But we do not
expect to see Chinese growth collapse. Rather, we see the Chinese economy
reaching its industrial capacity. Capacity, in this sense, is measured
not just by inflation (although wage inflation continues to erode Chinese
competitiveness), but also by environmental factors.
provides an opportunity for market share gains by other populous emerging Asian
nations, but will also be met through the on-shoring of manufacturing –
particularly in the US. The crucial distinction to make is between
Chinese final demand growth, which ought to continue as the economy matures,
and Chinese supply growth, which ought to slow. The global economy has
ample supply, which is why inflation and employment have shown such a muted
response to the extreme monetary stimulus of recent years. A Chinese
slowdown is therefore a useful step on the road to normalisation.