Theme – A blip in growth or more slowdown to come?
The two most frequently asked question over the last month are a) will the economy continue to slow after the weakQ1 GDP and b) why is the currency strengthening and will that continue with a weaker growth? Our conclusion is thatgrowth will hit a soft patch from over-extended exports but will reaccelerate into 4Q to hit our 8.1% growth forecastfor this year. The currency will continue its gradual appreciation from structural and cyclical factors. Below is why wethink so.
Before we move forward, here is a brief background on the framework on how we analyze the Chinese economy. Wefocus on three main drivers 1) external demand 2) internal or domestic demand and 3) policy, mostly monetary, whichaccelerates or decelerates domestic demand. We focus on these three for the following reasons. First, China remainsthe manufacturing center of the world and external demand (exports) creates big cyclical swings. Exports generateincome for businesses and households and they influence domestic demand by spending that income on investmentand consumption. Second, China has domestic or internal demand and here we focus on investment rather thanconsumption since as many of you know, China’s investment is much bigger than consumption (almost 50% of GDPcompared to 35%). In addition, investment swings are more volatile than consumption and is the main driver ofcyclicality since consumption includes more “necessities” and cannot be cut drastically in economic downturns.Third, we classify monetary policy as the third main driver since in a world of low external demand, many economies,including China are relying on credit growth or leverage to generate higher growth. Furthermore, in China, much ofthe investment growth is supported by borrowing and change in monetary policy alters investment growthsubstantially. Now, many other factors impact the Chinese economy but we see these three as the biggest drivers andthe others would be sub-drivers that fit within them.
So how are these drivers looking?
The biggest change we see is weaker short term export outlook. Our US economist, Mattias Bruér sees slowdown inQ2 and Q3 this year, led by large inventory accumulation in Q1 (pulls growth forward) and fiscal tightening fromsequestration (see
Economic Insights, US economy 8 Apr 2013
). We are already seeing some signs of this from weakerUS ISM data and softening in China PMI. In addition, China’s exports are already at elevated levels, growing at almost20% yoy, which are as strong as pre-Lehman crisis levels in 2008 (Chart 1). This is difficult to sustain with lingeringEuropean risks and US going through a soft patch. Japan is turning around and can generate some demand but asChart 2 shows, it is a much smaller export market compared to US and Europe. Exports will likely level out or slowdown over the next quarter or two before we see it accelerate towards year end. We do not see a major slowdownsince our SEB China Financial Survey tells us that on the ground CEOs and CFOs in mainland are becoming moreoptimistic about the business climate for the coming six months (
China Financial Index, Rebound in China Confidence,5 Mar 2013
). Our index has jumped to 60.8 in March from 56.1 in September and profit expectations and fixed assetinvestment plans have substantially improved.On domestic demand, we focus on construction activity as the main driver of investment. The SEB ChinaConstruction Indicator continues to be strong (Chart 3). The question is more on the outlook since authorities haveintroduced new measures to control rising house prices in March. We think the measures will slow the pace ofacceleration in construction activity and stabilize around 20% yoy compared to the 40% yoy growth we saw in 2009.We do not envision a collapse in construction activity from the tightening measures. As you can see from Chart 4, theproperty price acceleration is concentrated in first tier cities (e.g. Beijing, Shanghai, Shenzhen) and the most of thecountry, which are in third tier cities and below are not experiencing similar price increases. The measures aretargeted at decreasing speculation and activity in first tier cities and the impact on the overall construction activityand economy will be muted in our view.Thirdly, monetary policy still remains accommodative. Real rates are barely positive at 0.9% (Chart 5, 1 year depositrates are 3% minus March CPI of 2.1%). In addition, as our regular readers know, we have been talking about growthin non-bank lending acting as another form of monetary stimulus (
Asia Strategy Comment, China Trip Notes, 12 Dec 2012
) and it continues to accelerate (Chart 6). Recently, the authorities passed measures to control wealthmanagement products that may slowdown the pace of non-bank lending growth. However, we think non-banklending will continue to grow until we see two key changes, which we have yet to see. One, we’re looking for multipledefaults on domestic corporate bonds or trust/wealth management products that will teach investors that thesehigher yielding assets come with higher risk and dampen demand. So far when these products miss payments,typically a government, bank, asset manager or a company has come to the rescue. Until investors are taughtlessons, we think money will continue to pour into this area. Two, we need to see the central bank hike deposit rates.