After three weeks of financial market turbulence in China, the good news is the Chinese economy is still here, and the world’s second biggest economy continues to grow strongly – much more so than any other major economy. In view of the deep dependence of the Australian economy on China’s – China alone takes more exports from Australia than the next four trading partners, excluding Japan, combined – this, of course, matters hugely for Australia.
Yesterday’s release of second-quarter and first-half data confirmed that GDP growth is easing, but remains within the Chinese government’s target of around mid-7 per cent year-on-year. For the record, though the attention markets give to a few basis points change in China’s data implies a precision in the data which does not exist, second-quarter GDP was up 7.5 per cent and first-half up 7.6 per cent, year-on-year. Cynics will point out that the second-quarter result was smack on the government’s own target. Too good to be true?
Some analysts prefer proxies for GDP. The most frequently used of these is power consumption. Data just released from the National Energy Administration shows power consumption in the first six months increasing 5.1 per cent, year-on-year. The rule of thumb is that GDP growth is a multiple of 1.5 times growth in power consumption, which would also be exactly in line with reported GDP growth. Some will say this is also too good to be true, and so it may be.
But then the official Purchasing Managers’ Index has also recently been released, which shows continuing but milder expansion at 50.1. However, just as with the GDP numbers, the PMI shows the economy to be slowing from the previous month when the PMI was 50.8.
If we look at successive quarters rather than year-on-year comparisons, we see that Q2 growth was virtually unchanged from the first quarter – down from 7.7 per cent to 7.5 per cent. Whereas, last year, the drop in GDP growth from the first to second quarter was much greater than this year – down from 8.1 per cent to 7.6 per cent.
It should also be noted that this has been achieved even though growth in China’s exports in June were down 3.1 per cent on a year earlier. For years analysts have fretted about China’s heavy reliance on exports to drive growth but this is now an old story. Fixed asset investment is still the main driver of growth, increasing 20.1 per cent in the first half, almost unchanged from a year earlier. Meanwhile, retail sales were up 12.7 per cent on the first half of 2013.
According to a Xinhua report released on Monday, investment accounted for 53.9 per cent of first-half GDP, consumption (including government consumption as well) 45.2 per cent and net exports just 0.9 per cent. The role of investment has been wound back a long way from the post GFC-period of super charged monetary stimulus.
The conclusion analysts and markets should be drawing then is not that China’s GDP growth is slowing, but rather that it is stabilising around the government’s target rate of growth. It might be too early to conclude that a ‘soft landing’ has been achieved, but the government seems comfortable with current growth rates. Accordingly, as it has said on a number of occasions, struggling sectors can forget about more financial stimulus.
Last weekend the newly appointed Minister for Finance, Lou Jiwei, speaking in Washington, created a frisson among analysts when he was reported to have said 6.5-7 per cent growth would not be “a big problem”. This was widely seen as Lou preparing the ground for a worse than expected figure. The official news agency, Xinhua, was left scrambling as it sought to change his words to say “7.5 per cent”. After the confusion three weeks ago over the spike in inter-bank lending rates, these remarks added to the sense of the new team of economic managers being unsteady.
In recent remarks, Premier Li Keqiang echoed this insouciance saying that as long as key indicators – especially unemployment – do not slip below lower bounds and inflation does not rise too much, macroeconomic settings will remain unchanged. Encouragingly, he said policy in these circumstances would “focus on restructuring and pushing reforms”.
So why the panic in recent weeks when the credit shock hit? Markets have for some time been excessively nervous about China, or excessively speculative. In part this is attributable to the continuing weak international outlook. China has been one of the few bright spots – though not the Chinese stock exchange, which is still at a fraction of its pre-GFC highs.
China also has some real problems in its financial system. Reform and better regulation are urgently needed. The temporary credit shock was said to have been a shot across the banks’ bows to get them to pull back on lending to the informal financial sector, especially Ponzi-like wealth-management funds. If in fact this was true, it was a clumsy move but it did serve to make the point that banks had to be much more prudent in their lending.
The size of the shadow banking sector – a catch-all term for off-balance sheet lending by banks – has increased from about RMB 10 trillion in 2010 to more than RMB 37 trillion. Some RMB 17 trillion is in trouble, split evenly between property investors and municipal governments.
Much attention is paid to the so-called speculative bubble in property, but each year China needs to build a minimum of 10 million housing units just to keep up with normal growth in demand. Unlike in the US individuals are not highly leveraged, although many property development firms, especially in second and third-tier cities, are at risk from the government’s credit tightening. The government is prepared to let some of these go under. For first-tier cities, property prices are still rising at about 20 per cent per year so investors in these areas are not at risk.
Municipal government debt is a bigger risk as borrowings have been used to fund mainly infrastructure projects that yield returns only over the long term. This investment has been one of the mainstays of China’s GDP growth. We understand that the government plans to issue bonds to fund a continuation of municipal infrastructure development while forcing municipal governments to clean up their balance sheets.
The government is clearly determined to maintain growth around current levels. It seems comfortable with how the economy is tracking and says it is determined to tackle problems in the banking sector. Rebalancing from exports to domestic demand is well advanced and from fixed asset investment to consumption has begun. It was always going to be a slow process so those among the analysts looking for shock therapy will inevitably be disappointed.
More sustainable GDP growth, such as the current set of data reveal, should be welcomed by Australia. When people are worrying about China’s growth being a few percentage points below where it was six or seven years ago, remember that the absolute size of the economy is almost twice as big. China is also still a poor country in per capita income terms, which means that growth will continue to be resource intensive for many years to come. Two cheers for China’s latest growth numbers!
Dr Geoff Raby is chairman and chief executive of Beijing-based advisory firm Geoff Raby & Associates, and a former Australian ambassador to China. He is a Vice Chancellor's Professorial Fellow at Monash University and a member of the Board of Directors of Fortescue Mining Group and Yancoal Australia.