Talking Point

No more bets, please

Time to spin the wheel on another round of stimulus spending?

Red alert: China’s GDP growth seems to be slowing faster than policymakers anticipated

It’s not a wager that’s going to give either side an immediate pay-off, given the outcome will take almost eight years to decide. Nevertheless in March The Economist magazine agreed to a bet proposed by Michael Pettis, a finance professor at Peking University’s Guanghua School of Management.

His wager was that China’s GDP growth will not come in much above 3.5% – in real terms – for the rest of the decade. That, he reckons, will be the price China has to pay if it is to rebalance its economy, weening it off government investment towards a greater reliance on domestic consumption for its growth.

The Economist took the bet, suggesting a bottle of baijiu (Chinese liquor) for the winner. So both parties will be watching closely now that China’s economy seems to be wobbling. They’ll be looking too at confusing signals from other economic data, as well as signs that Beijing is ready to shore things up with another round of stimulus spending. All told, it looks like this wager could be an interesting one.

Why the focus on the GDP numbers?

They are still the most widely followed piece of economic data, especially for Chinese news editors long accustomed to serenading a strong performance.

But the headlines in recent days have been a little different in that respect. “Rescuing 8% growth” was one from the Economic Observer (we first talked about the resonance of 8% as the GDP target three years ago in WiC8). The China Daily also succumbed by mentioning that 8.1% growth in the first quarter came “close to the government’s tolerable bottom line”. And Capital Week has been pitching in too with grave references to the “growth imperative”.

If anything, GDP seems to be holding up better than a slew of other economic data, including slowing industrial production, lower tempo retail sales, weaker exports and receding housing prices. There has even been a sell-off in Macau casino stocks, prompted by anxiety about the subdued economic conditions.

Cue back seat muttering (from overseas, mostly) about whether the GDP picture looks too rosy, given the gloomier economic tableau.

In the past there have been similar doubts, most notably in 1998, the year after the Asian Financial Crisis, when China reported resilient performance even as the rest of the region was imploding around it.

The problem then was that the 1998 GDP growth number looked out of synch with weaker reports on trends that should have been tracking top line growth, like cement production and airline passenger volumes.

The discrepancy piqued the interest of economists, who switched on their calculators. Some concluded that the official GDP growth figure looked implausible, with one or two hazarding that growth probably wasn’t much better than zero.

Although a few eyebrows have been raised again this year, there isn’t the same level of scepticism as in the past. Data collection is much improved, and the dangers of reporting faulty information better understood. Despite the “protect 8%” mantra in the local media, China’s leaders are also getting more comfortable with a more subdued set of numbers. After all Chinese premier, Wen Jiabao advised the National People’s Congress in March that the new target was 7.5%, down on former levels.

Wen will expect to do better than that, of course, just as previous targets were surpassed year after year. The economy grew 9.2% last year and by 10.4% the year before. But the lower horizon is still a signal that the days of double-digit growth are over, and that a regular dip below 8% looks much more likely in the foreseeable future.

In part that’s because of China’s tremendous success in growing into a $7.3 trillion economy: the law of large numbers (which often works in its favour) makes it increasingly difficult to generate the same percentage bump.

Nor are the factors that drove years of turbo-charged growth still quite as productive. As the World Bank pointed out in February (WiC140), the danger is more that China will be caught in the “middle income trap” if it does not instigate another round of major reform.

And as The Economist suggested last month, other parameters are changing too. China doesn’t need 8% growth quite as it did in the past, when the primary goal was to create jobs. The proportion of the population of working age is starting to fall and this loss of demographic momentum means that the economy no longer needs to grow as quickly.

What other indicators are worth looking at?

Often it’s the anecdotal insights that get the media attention, especially if they seem to point to a deeper economic trend. Hence the headlines for the 51% drop in sales of bulldozers in March compared to the year before (construction falling off a cliff, perhaps?) or the news that eight of the 10 largest shipyards hadn’t received a single new order between January and April (a grim outlook for international trade, maybe?). Also telling: Hong Kong retailer Halewinner Group told the Wall Street Journal that luxury watch sales to mainlanders were down 15% in last month’s ‘Golden Week’ holiday period versus the year before.

Ask Li Keqiang – the man tipped to become country’s next Premier – how he takes the economic pulse, and it’s unlikely that he would be reaching for the GDP figures.

In fact, Li’s reservations are well known, following the leaking of a conversation with then-US Ambassador to China Clark Randt five years ago. He is said to have remarked that he prefers to assess bank lending, electricity consumption and rail cargo volumes. “By looking at these three figures, Li said he could measure with relative accuracy the speed of economic growth. All other figures, especially GDP statistics, are ‘for reference only,’ he said smiling,” the leaked cable reported.

So how do Li’s three criteria look today?

Looking at bank loans first, the situation seems bleak. According to Bloomberg, unattributed sources at the People’s Bank of China think that the country’s leading banks will fall short of loan targets for the first time this year in seven years, following declines in lending in April and May. Total new loans for 2012 look like reaching about Rmb7 trillion ($1.1 trillion), less than the government’s target range of Rmb8-8.5 trillion.

New Century Weekly says that this could also be understating the drying up in credit in the real economy, as almost three quarters of the money lent this year is in short-term notes payable within a year. “Because banks are reluctant to make long-term loans, or don’t have enough long-term lending projects that meet their conditions, note financing is being used to meet quotas,” a corporate lending department source told the magazine.

The implication: the authorities in Beijing want to pump more money back into the economy. But bank lending itself is at standstill as demand for credit shrinks, with the latest property market boom a thing of the past, and thanks to a weakening outlook for exports to key markets, including Europe.

There are countervailing views here, including those of Jonathan Anderson at Emerging Advisors Group, who warns against overreacting to the credit slowdown. Firstly, this is lending from the Big Four banks, which accounts for a little under half of the banking system’s total assets. Second, knowing what is going on at the Big Four is not necessarily a guide to the remainder of the industry. Thirdly, new credit extended in the first four months of the year was above pre-global financial crisis averages, implying that lending is still “running relatively hot”, says Anderson. And who’s to say that months of policy pressure to rein in credit growth isn’t as much a factor, rather than a drop in underlying demand for lending itself, he asks?

The picture on power consumption, another of Li’s indicators, can also get complicated, with two sources of data sometimes used interchangeably in the commentary.

April’s numbers provide an example, with power output showing an increase of just 0.7% in year-on-year terms, or very poor performance indeed.

But if it is power consumption being discussed (which includes electricity generated by smaller power plants and not included in the output figures) the story is a little better, with 3.7% growth on a year earlier.

Nonetheless, it’s hardly a matter for celebration when the comparison for April last year showed an increase of 12%.

There are contrarian views on the reliability of the power figures too. One suggestion is that the most recent numbers ignore seasonal factors, and that a heat wave last April created a higher base for comparison, by boosting demand for air conditioning.

Another is that lower power consumption could equally well be taken as a sign of more efficient energy usage.

China Securities Journal claimed something similar this month – that the power slowdown marks the ongoing shift towards the services and technology sectors, and away from older, more energy-intensive industries.

That will only be proved with time, although the suspicion is that there might be some clutching at straws going on in the current analysis. At the very least, the upticks in power usage this year look small compared to previous years, when the increment has often been double digit. There’s a similar story for rail freight volumes, which have been increasing by low single digits in percentage terms since the beginning of the year. Growth, true enough. But still at half the pace of last year.

Surely policymakers will respond to a further slowdown?

That’s the expectation from the markets, which rallied when Wen talked about “giving more priority” to growth on May 21. And since then a policy outline has begun to take shape, including boosting household consumption with subsidies, the fast tracking of key infrastructural projects, and proposals to lower the corporate tax burden.

A new bout of spending is needed, agrees Frederic Neumann, in the first of two new pieces of HSBC research discussing the potential for another round of stimulus. Fortunately China has more financial firepower than most with its “comfortably low” ratio of government debt to GDP leaving a “vast armoury” at the disposal of the economic planners, he says.

HSBC’s equity strategy team in Hong Kong (Steven Sun, Roger Xie and Garry Evans) concurs that the central government is ready to act. But this won’t be a stimulus on the Rmb4 trillion scale of before, they warn. The plan is to avoid the type of V-shaped rebound that prompted such nasty side effects last time, including inflation and murky debt deals between the banks and local governments. Significantly, there has been no mention so far of changes to monetary policy or an end to the current restrictions on property sales in many cities.

An editorial from Xinhua spelled out a similar point this week. “The Chinese government’s intention is very clear: it will not roll out another massive stimulus plan to seek high economic growth,” it warned. “The current efforts for stabilising growth will not repeat the old way of three years ago.”

So how will it work?

The suggestion is that spend will be lower (by at least half) and much more targeted than before. The message is that this will be a smarter ‘surgical’ stimulus, rather than a staggering one. One example is a new Rmb36.3billion ($5.69 billion) subsidy scheme to boost sales of energy-saving cars and more energy-efficient home appliances. The goal is more than growth, with environmental objectives also targeted.

Another new direction could be to encourage more involvement from the private sector. HSBC says new policies will encourage much wider private investment in industries like transport, power generation and oil – all sectors monopolised by the state-owned enterprises. The aim is an economic fillip but in a way which avoids private enterprises being crowded out by state firms, as they were in the last round of government stimulus spending.

The obvious query is whether the planners can deliver on their promise of a smarter programme. The bearish stance is that China is merely repeating previous mistakes for a short-term return. And the warning is that each time the economy gets pump-primed, the harder it becomes to transition to the more balanced model that Beijing says it wants, including a bigger share of GDP from domestic consumption.

On the other side are those who think that China has a little more time on its side, and that stimulus spending can be deployed in a productive fashion for a while longer. Arthur Kroeber, managing director at advisory firm GK Dragonomics, is in this camp. He suggests China’s economy today can be compared to South Korea’s or Taiwan’s around 1980 – and both of these countries enjoyed many more years of fairly rapid growth.

In an uncertain outlook, one thing’s for sure: Pettis and the editor of The Economist will be watching the numbers carefully.


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