China: Stable for now

China: Stable for now

China: Stable for now

Global Economic Outlook, Q4 2013

Strong industrial production, improving exports, and a rebound of credit creation suggest a stabilization of Chinese growth after a period of deceleration.

China_spot1The economic slowdown in China appears to be over—at least for now. China’s government has provided modest stimulus aimed at stabilizing growth, and there are indications that it is working. The stimulus included extra spending on infrastructure and easing of credit conditions. Consider that China’s industrial production was up 10.4 percent in August versus a year ago. This was the fastest rate of growth in 17 months. This is consistent with other recent data that pointed to a recovery in China’s growth, including exports. In August, China’s exports were up 7.2 percent from a year earlier. This was better than expected. Exports to the United States and the EU were up. Exports to Southeast Asia were up a staggering 30.8 percent. Exports to Japan, however, were down for the seventh consecutive month, reflecting political tensions between Asia’s giants. On the other hand, Chinese imports were weak in August, rising only 7 percent (below market expectations) and suggesting weakness in domestic demand. The result of these indicators was an increase in the trade surplus.

There were other positive indicators as well. First, Markit’s purchasing manager’s indices (PMI) for both manufacturing and services improved in August. The PMI for manufacturing went from 47.7 in July to 50.1 in August. This was a significant shift. A reading below 50.0 indicates declining activity while a reading above 50.0 indicates expansion. The August reading was the first indication of expansion in four months. Still, a reading of 50.1 suggests slow growth. Also, the sub-index for export orders was in negative territory for the fifth consecutive month, boding poorly for a continuation of strengthening exports. As for services, the PMI went from 51.3 in July to 52.8 in August.

Second, retail sales in August were up 13.4 percent from a year earlier. This was the fastest rate of growth this year. Third, credit growth took place after four months of decline. While this may be worrisome in the longer term, it boosts economic activity in the short term. Specifically, bank lending increased by 711 billion yuan in August while total social financing, a measure that includes bank lending as well as non-bank credit creation, increased by 1.57 trillion yuan in August. On the other hand, growth in property investment decelerated slightly in August.

The fact that bank lending accounted for less than half of the growth of credit is cause for longer-term concern. It means that the unregulated and unsupervised part of the credit industry (including the issuance of wealth management products) is expanding once again, thereby possibly setting the stage for troubles down the road. It means that the credit squeeze of June is clearly over and that the government is now being accommodative in order to keep the economy growing. Indeed, the broad money supply accelerated in August as well. The government is caught in a difficult spot. On one hand, if it tightens credit conditions, growth will most likely falter. On the other hand, if it allows non-bank credit to continue growing rapidly, it could face crises in the future that emanate from the creation of bad debt. The challenge for the leadership will be to reform the financial system in a way that avoids a disruptive financial crisis.

The fact that bank lending accounted for less than half of the growth of credit is cause for longer- term concern.

Dealing with banks

Worried about the stability of China’s financial system, the government is looking for ways to boost bank safety. As such, the government is encouraging banks to raise capital from the private sector. The government wants Chinese banks to meet the requirements of Basel III. Just a decade ago, the government was forced to bail out troubled banks by setting up asset management companies to take over bad assets. The government would like to avoid doing this again. Recently, the government said that banks can issue non-tradable preferred shares as a way to boost capital. The government specifically noted the US experience of having AIG issue such shares in order to restore capital. One problem for the government is that it is not clear to what extent Chinese banks are at risk because they have securitized many loans into Wealth Management Products (WMPs). These loans, whether performing or not, are no longer counted as part of bank assets. Thus, the non-performing loan (NPL) ratio for banks is roughly 1.0 percent. Yet it is widely believed that if banks wind up covering the losses of WMPs, the potential liability of Chinese banks could be substantial. Hence, there is a need for more capital. And if the banks fail to cover the losses of WMPs, there will be many unhappy wealthy and influential individuals who have purchased these securities.

Worries about the housing bubble

Among the worries vexing China’s leaders is the continuing rise in house prices. Savers are putting money into housing for lack of good investment alternatives. With equity prices stag­nant, bank deposit rates fixed, the bond market under-developed, and few opportunities for overseas investment, the property market is one of the few places that people can put their money and expect a decent return.” Please change the word “that” to “where” so it reads “…the property market is one of the few places where people can put their money and expect a decent return. In July, new home prices were up 10 percent from a year earlier. Equity prices during that same period were down 10 percent. The problem is that house prices could fall if and when the central bank tightens monetary policy. This could set off the financial crisis that has been feared for some time. On the other hand, it could be argued that the housing market in China does not possess the attributes of a bubble. The rise of the middle class, combined with a lack of satisfactory housing choices, warrants a rise in prices. Thus, prices reflect true supply and demand conditions rather than a speculative bubble. Still, the well-publicized existence of massive ghost cities suggests that a degree of over-building has taken place.

What to expect in November

At the Communist Party Plenum in November, the government is expected to announce the details of its economic policy going forward. It is widely anticipated where this will be the occasion for commencing the process of reform. Indeed, Premier Li said that his focus is on reform rather than stimulus. He recently said that an “important part of economic-system reform is financial reform. It is because it is such a complicated systematic project it indicates China’s reform has entered a deep-water zone, or the most difficult phase.” This will, of course, be critical to shifting the economy away from dependence on investment and toward growth based on consumer demand. It will also be important in avoiding a financial crisis. Of particular importance will be liberalization of interest rates. However, financial reform is only one part of the equation. It is also anticipated that the government will announce reforms involving internal migration, social services, investment in human capital, and environmental issues.

The problem is that house prices could fall if and when the central bank tightens monetary policy. This could set off the financial crisis that has been feared for some time.


Dr. Ira Kalish

Dr. Ira Kalish is chief global  economist, Deloitte Touche Tohmatsu Limited.

Global Economic Outlook, Q4 2013: China
Cover Image by Jessica McCourt