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Since June, when China’s stock market first started to falter, sentiment surrounding China and its prospects for growth have deteriorated markedly. Even so, the IMF left its forecast for Chinese economic growth this year unrevised at 6.8% in its latest World Economic Outlook. While that falls comfortably in Beijing’s target range of “around 7.0%”, it is divergent from the emerging consensus. Indeed, many now widely dismiss China’s official GDP statistics as little more than propaganda, and growth forecasts are slowly drifting closer to our own view. We have warned for years that China was at risk of a hard landing, and our China Momentum Indicator now suggests that growth is closer to 3.0% per annum.
Triggering this shift in sentiment is the realisation that China’s authorities are not as omnipotent as once assumed. Not only have their interventions failed to prop up the domestic stock market, but there is little evidence to suggest that they have successfully arrested China’s downturn. According to the Bankers’ Expectation Survey, which gathers views from nearly 3000 bankers in China, even slashing the benchmark lending rate five times since November has done little to encourage loan demand.
In response, and as we predicted, China’s authorities are reaching for the full range of policy levers. The most recent example, enacted on the 1st October, is a halving of the tax rate applied to the purchase of small vehicles. A similar policy response was exercised in 2008, at the height of the global financial crisis. Back then, it was global growth that was imploding, now the problem is home grown.
In contrast to other commentators, we do not believe that China’s slowing is a consequence of a strategic shift away from investment and export-led growth toward consumption. Instead, we consider it the inevitable fallout from China’s unsustainable and poorly executed credit splurge.
For anyone still clinging onto the notion that China’s authorities have the ability to engineer a smooth transition, this week’s trade data surely casts doubt. In the 12 months to September, Chinese imports dropped 20.4% in US dollar terms. Marking the eleventh consecutive drop, this pushed China’s trade surplus to a record high. While this deterioration has been aggravated by softening commodity prices, the import of consumer goods has also slumped — down 4.1% in the twelve months to August (the most recent available data). Exports also appear to be faltering, with weaker global demand and falling commodity prices causing a drop of 3.7% in the twelve months to September.
Even investment, the backbone of China’s economy, is unlikely to perform any better. According to official statistics, the rate of urban investment growth has slowed to a sixteen year low and we suspect that as a share of GDP it has probably peaked.
As we examine in more detail in our upcoming quarterly Global Economic and Markets Outlook, investment booms almost always turn to busts. China’s boom has already outlasted those of Japan and the so-called Asian tigers. And, according to our calculations, these economies suffered, on average, close to three years of economic stagnation after their investment peaked. Put simply, other components of economic growth failed to pick-up the slack.
We very much doubt that China will prove to be the exception. As our chart demonstrates, as of end-2014, there was little evidence to suggest that a transition was taking shape, with investment still accounting for the bulk of Chinese nominal GDP. More timely data, such as retail sales, point to a softening of consumer demand.
China’s policymakers’ inability to calm financial markets, combined with their disorderly depreciation of the renminbi, has probably aggravated the downturn. Evidence suggests that both investors’ and Chinese citizens’ faith in the Communist Party’s competence has been hit, resulting in a weakening of confidence indicators since the beginning of the year.
Without favour, gaining policy traction is likely to prove that much harder. All the while, volatile financial markets serve as yet another impediment to a more consumer-led economic growth model. Indeed, drastic corrections risk hitting consumer confidence, and with it consumption.
It is also likely to dent the service sectors contribution to GDP. Growing at a faster pace than the economy as a whole, some have touted the tertiary sector as China’s next growth engine. However, data suggest that this has been boosted by financial intermediation and the stock market boom in the first half of the year. Now that the stock market has collapsed, growth in financial services is likely to have slowed.
As our chart demonstrates, other service sectors have performed insipidly since the global financial crisis, suggesting that they are unlikely to pick-up the slack.
From our perspective, a strategic rebalancing by the Communist Party is not the cause of China’s downturn and nor is it likely to prove the solution. In order to restore growth, we look to the People’s Bank of China to write-off non-performing loans so as to unencumber the financial system. This would be akin to the Federal Reserve’s Troubled Asset Relief Program (TARP). In the meantime, we expect conventional policy loosening to go much further than markets are currently pricing in.
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