March 17, 2017

A change of tactics in China remains unlikely

by Fathom Consulting

In Premier Li Keqiang’s annual ‘work report’ presented at the National People’s Congress (NPC), the official growth target was set at ‘around 6.5%, or higher if possible’ for 2017. This is just 0.2 percentage points shy of what was achieved last year. Li said the slower growth rate was set to ‘control risks and ensure safety in the financial sector.’ We agree this should be high on their priority list –  our own estimate of non-performing loans is close to 30% of GDP. However, data out on Tuesday for the first two months of the year along with other annual targets set at the NPC suggests the credit binge in China is not yet over and the plan to rebalance the economy towards consumption remains on hold.

China official

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Sustainable rebalancing, when and if it comes, means investment will fall sharply, not just as a share of GDP but in absolute terms too. That will almost certainly produce a slowdown in economic growth in the short term, even if consumer spending takes off. In 2014, many commentators believed this time had come. But slower investment growth was to blame, without any boost to consumption growth, which is much harder to achieve.

China nominal

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Since the beginning of last year, growth has picked up from its low of around 2.2% according to our China Momentum Indicator (CMI). This is not due to consumption but investment, as a consequence of Chinese policymakers’ decision to ‘double-down’ in a bid to re-start the economy. The volume of retail sales in January and February compared to the same period in 2016 grew by a record low of 8.1%.

China retail

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Meanwhile, this year’s NPC target for annual fixed investment growth of 9%, if met, would constitute a rise from the 8.1% achieved in 2016. Much of this is likely to be allocated towards unprofitable projects in sectors which already suffer from excess capacity, such as real estate.

china urban

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Data out on Tuesday support this. Residential construction growth in the first two months of this year increased by 9% compared to the same period in 2016 – a two-year high. This is despite 407 million square metres of unsold residential floor space. To put this into perspective, the average amount of floor space owned per capita in 2012 was 35 square metres, meaning there are currently 11.7 million residential properties waiting to be sold in China.

China residential

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At the NPC, Premier Li said ‘stability is of overriding importance’. This reinforces our expectation that the switch to a long-run sustainable growth path in China is not on the cards in the short-term future. This tactic of low consumption and continued investment in unproductive areas will increase the count of non-performing loans, and the already substantial risks in the banking and shadow-banking industry. Therefore, we expect Chinese financials to underperform the wider Chinese equity index. To reduce exposure to the volatility seen in the Chinese equity market, we prefer relative value positions.

MSCI China

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