Much ado about 20 basis points in China

Analysts decrying a slowdown in Chinese GDP should look at the bigger picture to get an idea of where the country’s growth is really positioned.

Last week, when China’s first quarter GDP growth figure came in at 7.7 per cent, 20 basis points below the 2012 fourth quarter of 7.9 per cent, headlines around the world cried that China’s economy was slowing, the number was disappointing, China had stalled, and so on.  Financial market analysts hit the TV talk shows, warning of lacklusture growth from China, which would take the steam out of equities. And of course there was a big fall in equities last week.

But what is in 20 basis points? These same commentators would at other times have been intoning that Chinese statistics are inherently unreliable, fraught with errors if not outright political manipulation.  Twenty basis points are clearly within any reasonable margin of error.  As noted before here, in the case of China, these data should be read as indicative orders of magnitude. So to call the end of China’s growth on the basis of the data released last week is little short of irresponsible (Who’s afraid of China’s big bad rebalancing? January 31).

Some analysts who question China’s official GDP data turn to proxies such as growth of energy consumption. This year energy consumption growth has slowed, increasing by only 4.3 per cent in the first quarter compared with 5.5 per cent last year. The difficulty in using proxies like this, however, is that other things are also changing in the structure of energy demand.  For example, aluminium smelting is a huge energy consumer and relatively small changes in output will have a disproportionate impact on energy used.

China’s economy is about twice the size it was in 2006. Growth rates in the order of 7-8 per cent are therefore coming off a massively bigger base than just seven years ago.  So when in Australia we consider what a “slowing” Chinese economy may mean for demand for our major resource exports to China, we need to keep in mind that overall demand has doubled in recent years.

In the current five-year plan, the Chinese government set 7.5 per cent as the target rate.  This was the growth rate that was felt to be consistent with maintenance of price stability and the gradual rebalancing of the economy away from heavy reliance on investment to allow domestic consumption to drive growth.  The headlines last week could better have been “China’s growth continues to exceed government target”, or some such.

Another Chinese number that has captured a lot of attention recently is the level of local government indebtedness.  Concern over this prompted initially Fitch, and more recently Moody’s, to cut China’s outlook from positive to stable.  Last week the Financial Times reported that debt at all levels of government, below the national level, was some 20-40 per cent of GDP.  No one knows the true figure as much of it is raised in informal capital markets.

Again, while some of these numbers seem scary – and may very well be – they also need to be understood in context.  First, China has an extreme form of what we call in Australia “vertical fiscal imbalance”.  This means that the national government takes most of the fiscal revenue and then demands that lower levels of government supply services and infrastructure without giving them a fair share of revenues. As was the Australian experience, land sales and development have been the preferred means for funding such expenditure at lower levels of government.

Second, while countless examples of waste, extravagance and corruption exist in local government projects, it is at least arguable whether these low-return expenditures offset the returns from massive investment in infrastructure, urban development and other services.  Last week travelling in the far south-western city of Chengdu - a city of 14 million with the third highest car ownership in China, and which has been busily building and rebuilding itself over the past decade – it was amazing to see the huge road, rail and other major infrastructure projects underway.  These will yield returns for many decades to come.

Finally, while local government debt may not be strictly sovereign debt, Beijing would be most unlikely ever to allow a government at any level of responsibility to default on its debts.  Beijing has the financial capacity to deal with local governments should they really get themselves into trouble.  In usual style, it would be done quietly and may already be occurring.

But more than the quarterly growth numbers or the levels of local indebtedness, the really scary number to watch is H7N9. This is the name of the new strain of bird flu that has been quietly spreading throughout China. Secrecy is in the DNA of Chinese officials and, notwithstanding the World Health Organisation’s activism, few in China trust government reports on the disease.  If the four currently unexplained cases turn out to be the result of human-to-human transmission, this will really move markets and crunch China’s growth rate.

Dr Geoff Raby is chairman and CEO of Beijing-based advisory firm Geoff Raby & Associates, and a former Australian Ambassador to China. He is also vice chairman of Macquarie Group China and a non-executive director of Fortescue Metals Group.