China Outlook in a Nutshell: Growth, Housing, and Trade

Here is a brief summary of views on China's growth outlook for the remainder of 2015.  I am restricted by my employer from giving investment advise, so I will stick to broad fundamental views.  For views on PBOC activity, reforms, and policy, see other blog entries.

Growth outlook:

My economic growth outlook is based on three main factors:

  1. Economic activity, especially industrial activity, will continue to soften for some months before Beijing's stimulus measures kick in (see my blog positing "Things will get worse before they get better.")
  2. RRR cuts and fiscal measures will probably begin to boost activity - mostly in the industrial sector - sometime in the summer (see my blog positing "Beijing's stimulus steps so far: what do they mean for growth prospects?")
  3. Construction activity will finally begin to rebound and contribute to growth in the early fall (see my blog positing "Some housing data the only good data in April's ugly economic release.").  This will compound the effects of the fiscal and RRR cut measures in boosting Q4 growth.

Q1 grew at 7.0%, right on Beijing's 2015 target.  Assuming things get softer in Q2 before stimulus kicks in, I am forecasting growth moderating to the high 6%s.  Activity will be boosted in Q3 by the PBOC and fiscal stimulus, along with a consumption boost due to the wealth effect from house prices and equity market gains.  By Q4 property construction will begin to contribute and be additive to growth.  Most of the fiscal and PBOC stimulus will provide support to industry, so most of the pickup will take place in the industrial sector portion of GDP.

Here are my quarterly forecasts:

2015 GDP Forecasts by Quarter, Full Year GDP of Forecast 7.1% in 2015

Q1 is Actual GDP

Housing and construction outlook:

It will be extremely difficult for the Chinese economy to maintain robust growth rates without a positive contribution from the property market.  25 - 30% of the economy is tied to real estate directly and indirectly (urbanization infrastructure, steel, glass, cement, furniture & appliances, and the wealth effect.)  According to the IMF, real estate creates at least 14% of China's urban jobs.  The sector is stuck with oversupply, but with ten million new urban residents each year looking for housing, and significantly low-quality old housing being demolished, inventory can be used quickly when construction declines.  Construction has tanked over the last year. 

We have seen some positive signs from China's housing market (see my blog positing "Some housing data the only good data in April's ugly economic release.").  Sales and prices have turned positive in April after steep declines in the last year, which where in turn followed by declines in construction.  A drop in new units and the roll-back of mortgage restrictions in March has improved prices on an month-on-month basis.  Whether the renewed housing market driven partly by Beijing's efforts to ease mortgage lending will help the market in the short term at the expense of more long-term structural problems is up for debate.  In the short term however, the housing market is looking modestly better, and construction and resource demand will eventually look better this year.

Much of the housing weakness this last year came after a surge in supply in early 2014 (see chart below), exacerbating oversupply built up over years (perhaps 500,000 to a million units of excess supply annually beyond demand and a 20% vacancy rate).  New starts and construction have tanked over the last year.

Improved housing will have two main effects:

Home Ownership Rate

  1. The wealth effect from increasing prices will stimulate consumption.  Over 60% (according to Goldman Sachs) of household assets are held in property and homeownership rates are high (see chart on the right).  Historically, housing is one of the few investment options available in China, so ownership rates are high and investment properties are plentiful.  The improvement in prices should lead to a boost in consumption in Q2.
  2. Sales and price increases will eventually lead new starts, which will be a boost for construction.  This will in turn be a boost to commodity imports, iron ore in particular.  Heavy industries like cement and steel will improve.  Sales lead new starts by 6 months, so expect a construction pickup in the Fall.  Nearly half of all steel consumption goes to construction.  Construction is about a quarter of copper consumption.  

Trade and external position:

Going forward, the CNY will be flat and stable vs. the dollar, requiring continued liquidation of USD foreign exchange reserve assets.  Beijing will try to keep the CNY stable vs. the dollar for various reasons including lobbying the IMF to include the yuan in the special drawing rights (SDR) and maintaining economic restructuring plans.  Considering the PBOC is still easing while the Fed is ending its easing, growth is weak, and investment cash is flowing out of China, significant amounts of reserves will need to be sold to keep the CNY stable.

Exports have declined, as the CNY has appreciated nearly 20% vs. the EUR and 15% vs. the JPY over the year, dramatically reducing export competitiveness.  Exports will continue to stay weak for much of the year due to the currency policy coupled with subdued global growth.

Imports will continue to decline on a value basis, but expect the stimulus-boosting measures to improve import volumes. Copper, oil, heavy machinery, and consumption goods imports will get a boost in the summer from improved investment and the wealth effect.  Iron ore will see a pick-up once construction rebounds.

Year to Date % Change for Selected Commodities vs. Last Year

Crude oil: Crude import demand is expected to increase in H2 2015 for three reasons. First, cheaper oil and the wealth effect from better housing and share prices will improve consumption on a volume basis. Second, domestic production is expected to decline about 120,000 bpd as firms cut capital spending. Third, vast storage containment will come online in H2 2015 to fill China's strategic petroleum reserves. New strategic storage facilities with 50 billion barrels of capacity will be completed in H2.  Refiners are also expected to restock inventories in the tens of millions of barrels over the second half of the year.

Iron ore: Nearly half of China's steel production goes into construction.  A pick-up in the housing market will push iron ore demand higher by Q4.  On top of that, inventories have fallen significantly over 2015, and mining firms have cut investment and production.  Beijing's stimulus will help import demand for iron, but a construction rebound later in the year will bring about a significant pick-up considering the inventory drawdowns so far this year.  

China Copper Consumption % Breakdown

Copper: Copper import demand is expected to grow.  Demand this year is expected by Platts to run around 4-5%.  A pickup in construction will improve demand by the fall.  Beijing's expanded fiscal budget and the "war on pollution" will contribute further to a pick-up in demand.  

Copper stock levels are low, according to Platts, and an 11% decline in imports by volume YTD so far would imply that an import surge is inevitable sometime this year.