Despite stock market volatility, growth prospects look better for the second half of 2015.

There are encouraging signs that overall growth has improved very recently.  Retail sales, manufacturing, trade (see my post Quick Data Update: Trade Data Improves In June. The Improvement Is Much Better Than The Headline Numbers Imply. ), and investment all saw modest improvements in June.  The property market improvement has accelerated.  Housing prices in the top-tier cities are on fire, and sales are growing in the double digits.  Prospects look good for the second half of 2015, but we are coming from a much lower growth rate than the first half headline GDP growth number implies.

It is not all good news however.  Growth in the first half was worse than the headlines suggest owing to a big distortion that may not carry over into the rest of 2015.  And, growth in the industrial sector portion of GDP dipped below 6% already this year (the secondary sector of GDP grew at 5.8% in Q2).  For those worried about commodities and China's making and selling of tangible stuff (and not services), growth is effectively 5.8%, well below the 7% figure overall.  Imports of many key commodities have fallen in the double digits as policy reflation has yet to produce the expected growth boost.

So, expect improvements for the second half of the year, especially in construction and property linked sectors.  However, the poor showing in H1 will increase the risk of Beijing failing to hit the 7% target by the end of the year.

Here are some key factors for growth prospects for the rest of the year:

Growth overall seems to have improved in June.  

A number of indicators improved modestly in June.   The rebounding numbers were not massive, but the upticks were broad.  The data suggests at least a stabilization if not the front end of a cyclical rebound.  Industrial production, retail sales, fixed investment, services & manufacturing PMI, both imports & exports, and housing data all saw an improvement in June.  

April/May looks to be the low point of growth this year so far.  If we see fiscal measures deployed in the second half of the year, PBOC reflation measures spreading into the broad economy, and the property market acceleration all take place, then the rebound will most likely gain momentum.  If the policy reflation effort fizzles, then the rebound may be muted.

Policy reflation expectations.

While certain parts of the economy, property in particular, are showing tangible signs of meaningful improvement, the effects of PBOC easing and a planned government fiscal expansion are much more muted.  Total outstanding credit is still slowing (See chart), and fiscal stimulus has yet to be fully deployed.  Expectations of policy reflation are still mostly based on anticipation and not tangible evidence that reflation is taking place.

As far as the expected fiscal boost goes, fiscal spending usually accelerates in the second half of the year.  Although a budget deficit was targeted this year, China has netted a surplus in the first six months of the year.  If the budget deficit target holds up this year, the second half of the year should see more than 2 trillion RMB in spending unfold.  If spending plans play out for the rest of the year (I think they will), the stimulus will be a much-needed boost to the industrial and the construction sectors.

But, again, reflation expectations for the rest of the year are mostly driven by the anticipation of policy measures boosting growth.  That is a risk to growth prospects.  There is little evidence of stimulus deployment in the numbers so far.  Beijing is still running a fiscal surplus, total outstanding credit is still slowing, and without the extra boost from a transient surge in financial services GDP growth would be well below 7% so far this year.  For more on the risks to policy reflation see my post Reflation Troubles.

The housing market is on the mend.

China's housing market continues to improve.  Prices are rebounding, especially in the larger coastal economies.  Inventory continues to be drawn-down; housing sales are up 18%, and finished construction is down 17%.  There are a number of catalysts for the rebound: price declines, inventory drawdowns, policy easing, favorable mortgage rule changes, and homeowner upgrades.  Given China's demographic changes and existing inventory excesses in the hinterlands, the long-term prospects are murky.  But, for now we are at the front-end of a cyclical housing rebound.  That is good for the industrial and construction sectors.

 For more details see my post China's Property Market Continues To Improve.

GDP growth is lower than 7% if we remove a temporary distortion.

For the first half of the year, the GDP number was distorted on the upside.  The distortion was not due to manipulation by Beijing, but was instead a product of an unsustainable boom in the financial sector, at the very least encouraged by Beijing.  

GDP Growth Rates in H1 2015 by Sector

The financial intermediation portion of the H1 GDP number grew 17.4%, driven by the surging stock markets and record IPOs.  Without the additional one-off boost, growth would have certainly been below 7%, perhaps 6.5% for the year so far.  So, unless financial services can surge another 17%, which is highly unlikely, the second half of the year will need to see a meaningful boost from reflation and the rebounding housing market to make up for it.

See my posting 7% GDP growth? Probably not. for more details.

The secondary sector of GDP growth (industry and construction) is falling like a bag of hammers.  Services continue to fly.  

China's growth in Q2 was dominated by a fast-growing service sector, while the secondary sector (the building, making of tangible things) continues to decelerate.  Even after removing the unsustainable surge in the financial sector, the service sector grew over 8% in Q2, while the secondary sector struggled to a disappointing 5.8%.  The vast overwhelming majority of China's imports are meant for industry. So for those concerned with China's making and building of things, or China's commodity demand, Q2 effectively grew at 5.8%.  We see the results of sluggish H1 industry and construction in China's weak commodity demand this year (See the chart below).


Year to Date Commodity Imports (Volume) vs. Last Year to June 2015 (Percent Change)