Most of China’s data surprised on the upside in August and points to stable growth for now. But, there are some details in the data that point to prospects going forward
Here are three important things to note about China’s August data:
Investment data highlights the biggest risk to growth over the next six months.
Investment data is worrying for a number of reasons. First, as has been reported for some months now, private investment has stalled. That trend has pushed overall investment lower. August private investment was flat at roughly 0% growth after declining modestly in July. Overall investment over the last three months has averaged around 6.5%, some of the weakest growth in years. Most private investment declines have taken place in the hinterlands and rust belt provinces of the northeast. The wealthy eastern provinces grew at 7%, in contrast to the massive 30% drop in private investment in the northeast. And, within overall investment numbers, service sector investment is growing, while industrial investment is not (see chart). The recent rebound in investment, from 3.9% in July to 8.9% in August, was concentrated in services. That will result in much weaker industrial output months from now. The last major concern with investment in China is the difference that has grown between credit growth and investment growth. Over the last three months, investment has grown and an average of around 6.5%, while overall official debt accumulation has grown around 11% from last year. That could mean either debt is being used to keep zombie firms alive or used to fund consumption. Those are both problematic given China's sizeable growing debt burden.
So what does that all mean? My models indicate that the recent weak investment will likely amount to roughly a half a percent shaved off of real GDP growth. Investment historically leads output by 5-6 months. So, we could see weaker economic activity in a few months, but certainly by early 2017. The lower growth would come from the industrial sector, currently starved of investment. And regional disparities would indicate old economy rust-belt industries would take the brunt of the slowdown. So, the temporary reprieve for the old economy sectors we have witnessed this year is due to expire by the end of the year.
Construction is fading, housing prices are still rising.
Housing sales and prices continue to boom. Mortgages are up 52% this year as households begin to embrace debt. But, construction and developer activity has already started to fade. Housing starts have moderated, slowing to 3.4% from last year after rising in the double-digits earlier this year. Land acquisition by developers fell 12% in August.
The eventual fading of construction was bound to happen given the existing inventories. The loss of construction momentum will result in a renewed slowing of construction related industries, like steelmaking, cement, heavy machinery manufacturing. As with the recent investment slowdown, fading construction activity will eventually reverse the recent rebound in old economy heavy industries.
Property price growth has been positive for consumption. According to a 2015 NIH paper, housing assets account for over 70% of household wealth in China. The wealth effect from rising process has been good for consumption. Retail sales in August grew 10.6%, outpacing nearly all other months this year. Auto sales grew at 13% from last year.
Stimulus policies are more limited than in the past.
If the current weak investment results add more downward pressure on the economy, we will probably see Beijing act to boost growth. But, fiscal difficulties and corporate debt burden risks will limit the use of traditional stimulus measures, like easing and infrastructure spending. Beijing will probably need to rely on more supply-side policies, like targeted tax incentives or regulatory reforms to reflate private investment and stimulate growth.
Due to significant debt burden risks, the potential for more dovish monetary policies is much more limited than in the past. Much of China's upside credit growth surprise in August was caused by seasonal distortions. Total outstanding credit growth, in fact, remains subdued in comparison to historic rates, growing around 11% in August. But, that number is still higher than nominal GDP growth. China's debt burden as a percent of GDP is still growing. Corporate debt is around 140% of GDP, and much of that debt has been issued to inefficient unprofitable firms. Trust lending has bounced back and become a concern once again. And, debt creation is not translating into investment, implying that debt is being used for either consumption or used to keep zombie firms afloat. Those factors will limit the PBOC's willingness to ease monetary policy. Inflation running at 1.3% - below the 3% target – implies that there is room to ease. But, the real limitation to more rate cuts and reserve requirement reductions is the risk associated with the growing debt burden. August numbers show that the debt burden is still rising.
China's traditional infrastructure building engines, spendthrift local governments, are seeing revenue sources under pressure this year. That will restrict fiscal stimulus. Local government revenue pressures are coming from three main sources. First, tax reforms this year moved the remainder of sectors from the Business Tax (BT) system to a VAT tax system. Previously, BT taxes were collected by local governments. VAT tax revenues are split 50/50 with the central government, reducing tax revenue locally. Add to that the sizeable drops in revenue in the rust-belt regions as mining and smelting come under pressure. The resource-rich Liaoning province in the northeast suffered a 33% decline in government revenues in 2015.
Local governments get roughly a third of their revenue from land sales, and developers have already reduced land purchases.
Lastly, the crackdown on local government borrowing over the years has limited infrastructure spending potential.
Those limitations on easing and fiscal infrastructure spending will probably move Beijing to use less-traditional measures to stimulate growth, like reducing regulatory hurdles in order to get private firms to invest again, targeted tax incentives, or more migrant worker reforms to boost consumption. Going forward, economic support out of Beijing may not look like it has in the past, and therefore it is hard to know what sectors will benefit.