It seems the entire planet is bearish on China and questioning its economic data. But as most economists missed the bubbles created by China’s 2009 stimulus, they’re now missing signs of some economic resilience and a likely pick up in short-term growth as abundant liquidity starts to reach the economy. This means that China could once again defy the naysayers (I’ve been among them). Any short-term respite though is likely to lead to even greater dependence on debt to drive economic growth and more serious problems beyond this year.
Abundant Liquidity to Kick In
It appears everyone is an expert on China these days, even though many of these experts have never visited the country and certainly don’t know the first thing about its economy. And these “experts” have been befuddled by the recent economic data coming out of China.
On the one hand, some of the data has been weak. Chinese manufacturing saw a slowdown in April, with the official purchasing managers’ index (PMI) falling to 50.6 from 50.9 in March. Anything above 50 indicates economic expansion while below 50 indicates contraction.
This follows first quarter GDP growth which unexpectedly slipped to 7.7% from 7.9% in the previous quarter. And other key indicators have also suggested a slowing economy. For instance, retail sales grew 12.6% year-on-year (YoY) in March down from the 15% recorded in the fourth quarter on last year. The most likely explanations for this being a crackdown on corruption impacting luxury and department stores sales as well as some moderation in economic growth.
On the other hand, other economic data have been showing strength. For instance, exports increased 14.7% in April, up from 10% in March. And imports were also up 16.8% in April, from 14.1% in March.
The problem is nobody believes the export data. And rightly so, given the numbers clearly don’t add up. Suffice to say that Asia Confidential questioned the reliability of the export data before any sell-side analysts, who were probably scared of getting on the wrong side of Chinese officialdom. Now that the export figures are so blatantly wrong, sell-side questioning has become a team sport. Even my old shop, CLSA, has belatedly jumped on the “dodgy export data” bandwagon over the past week.
Other data have been positive though. Surprisingly, property investment has rebounded after property sales bottomed at the start of last year. Infrastructure investment remains resilient at close to 20% growth, where it’s been for much of the past 12 months.
There’s also been clear improvement in the production of key commodities including cement, steel and ethylene. This suggests that commodity producers have confidence in future demand.
Overall, the data haven’t been anywhere near as bad as many would have you believe. If anything, they’ve indicated a mild recovery from the third quarter of last year.
What’s confused most observers though is that a substantial uptick in loan and money supply growth hasn’t yet translated into a better rebound in growth, reflected in figures such as GDP and the PMI. For example, monthly social financing (total financing including formal and informal lending) in the first quarter of 2013 was Rmb2.1 trillion, higher than the monthly average of any single quarter since the introduction of the data in 2002. While the absolute number is high, it’s nowhere near the growth seen in 2009, though it does show a decent uptick.
There are a number of commentators suggesting that the reason that the resurgent liquidity isn’t filtering through to the economy is because there is a lack of demand for loans ie. in economic parlance, the credit transmission mechanism is broken. This doesn’t make much sense given the pick up in loan data.
More broadly, what these commentators don’t get is that China isn’t the West. Credit transmission mechanisms don’t break down because it is a command economy. If the Chinese government wants loans to reach the real economy, it’s going to get it. It controls the banking system and key players in vital industries. By contrast, the West can print money all the money that it likes, but it has little say about whether banks lend that money out (currently they’re not, reflected in the lowest money velocity figures in the U.S. in 60 years).
The real explanation for increased loans and money supply not reaching the real economy in China is that there is normally a six month lag effect. For instance, the first quarter of 2009 stimulus didn’t result in a rebound in economic activity until the third quarter of that year. Given much of the recent stimulus came late last year, you can probably expect a rebound in economic growth from mid this year.
To be clear, I’m not expecting a substantial economic rebound but a more mild one. The key point is that even a mild rebound should surprise markets, which remain overwhelmingly bearish.
Other Reasons for a Short-Term Uptick
Besides liquidity, there are other reasons to suggest that a mild rebound may be on the cards:
- The latest export data have been somewhat encouraging, even if you strip out the blatantly incorrect data. There’s little questioning of a mild uptick in exports to developed markets, particularly the U.S. and E.U. The biggest discrepancy appears to be the Hong Kong export data. Growth in Chinese exports to Hong Kong was an extraordinary 57% year-on-year in April and 93% in March. The discrepancy is likely due to over-invoicing in order to circumvent capital controls and bring foreign capital into China. The key point is though that if you strip out the Hong Kong figures, Chinese exports still grew 9% in the first quarter of 2013, up from 4% and 0% in the previous two quarters.
- The import data have been undoubtedly strong and no one has questioned these figures. This indicates improving domestic consumption. A key positive.
- Retail sales did tick up in March after a disappointing first two months of the year. The impact of the corruption crackdown is likely much broader than just luxury retail. Many government agencies and businesses have historically given gift-cards to employees during holidays seasons. This has clearly slowed, hitting department store sales. I think the odds though favour an easing in the anti-corruption campaign as the new government settles in and focuses on other priorities.
- Inflation remains subdued. Figures over the past week show producer prices – a measure of prices of goods before they reach the consumer – fell 2.4% YoY in April, the 14th straight monthly decline. It follows consumer price inflation (CPI) increasing 2.4% YoY in April. It’s true that credit growth normally precedes inflation by 6-12 months and therefore you’d expect an increase in inflation in the second half of this year. But given the credit growth hasn’t been of 2009 proportions, the impact on inflation and the economy should be more mild this time around. That’s assuming agricultural prices are relatively stable.
Still a Troubling Long-Term Picture
If the short-term may surprise low expectations, the long-term, beyond this year, still looks highly problematic. The reason is that the economy has become ever more dependent on debt-financed investment for its growth. The chart above, highlighting credit growth versus industrial activity – clearly demonstrates that dependency since 2009. It’s likely that the latest stimulus in the last quarter of 2012 has only delayed a sharper economic downturn.
There are four reasons why the current situation is expected to end badly:
1) Credit bubbles always eventually burst. It’s not China’s total debt to GDP of 190% which is most troubling. It’s the rapid 60% increase in that ratio since 2009. As asset manager, GMO, points out China’s expansion in credit relative to GDP is considerably larger than the credit booms of Japan in the late 1980s and the U.S. before 2008.
2) Credit booms that burst are almost always accompanied by property bubbles. There can be little doubt that there are significant real estate bubbles, particularly in the major Eastern seaboard cities. Government data suggest the value of unfinished housing stock represents an astonishing 20% of GDP.
3) The financing of the credit bubble is Ponzi-like. In essence, the central government and local governments have borrowed from largely state-owned banks to invest in increasingly low-returning assets.
4) The growth in off balance sheet banking, such as wealth management products, is of particular concern. Many of the trust loans have financed cash-strapped property developers. If you’re thinking that this has a whiff of U.S. subprime about it, you’d be right.
For these reasons, China’s latest stimulus package may have only succeeded in delaying a day of reckoning.
Investment Implications
If I’m right about a mild rebound in the Chinese economy surprising markets, there’ll be some significant investment implications for the second half of this year.
You could see China’s stock markets rebounding from current depressed levels. It wouldn’t take much for these markets to run given the pessimism surrounding them. The beaten-down cyclical sectors would be expected to take the lead.
You could well see a turnaround in the depressed industrial commodities too. Again, it wouldn’t take much for a turnaround given the negative sentiment towards these commodities.
Countries and currencies reliant on China may also show some surprising resilience. Think the likes of Australia and Canada.
More broadly, you could see renewed hope of a global economic recovery, with China leading the way. This may translate into further upside for stock markets outside of Asia, depending on the health of other major economies, such as the U.S. and E.U.
But let me stress that as a long-term investor, you’d be taking on significant risk if you choose to participate in any China-led rebound. If you want to speculate and trade it, fine. Be fully aware though that you’re likely to be picking up proverbial nickels in front of a steamroller because the long-term outlook for China remains dim.
Source: Asia Conf.
