China First
Quarter Economy Analysis
Summary
The Chinese economy grew 7.4 percent in the first quarter of
2014 versus a year earlier, and was up 1.4 percent from the previous quarter.
This slower growth was a continuation of the slowdown that has afflicted China
during the past year, although growth remained in a range that the government
has targeted. The big question is whether China can simultaneously sustain
growth while reducing its dependence on credit expansion.
China’s GDP grew by 7.4 percent for the first quarter of
2014, lower than the government target of 7.5 percent, but ahead of most
analyst estimates
• First quarter Purchasing Managers’ Index (PMI) remained in
positive territory at 50.3, while the Consumer Price Index (CPI) held steady at
2.4 percent (versus the government’s 3.5 percent target for the year)
• ODI in non-financial sector decreased by 16.5 percent
year-on-year in the first quarter, but a number of factors should propel total
Chinese ODI for 2014 above levels reached in 2013
• Inbound FDI increased by 5.5 percent year-on-year, as
China’s services industry buoyed investment growth
The Chinese economy grew by 1.4% this quarter.
Since the start of the year, most economic indicators have
pointed to a pronounced slowdown in China, the fastest growing major economy
for more than a decade and a powerful stabilizing force in the wake of the
global financial crisis (Anderlini, 2014) .
China's economy grew 7.4 percent year on year in the first
quarter of 2014, the National Bureau of Statistics (NBS) revealed recently.The
NBS said that preliminary data showed the nation's gross domestic product (GDP)
reached 12.8213 trillion yuan ($2.08 trillion) in the first quarter (China Daily,
2014) .The
figures suggest growth in the world's second-largest economy in the beginning
of year 2014 was stable and that the economy was generally in good health, as
Chinese authorities promoted reforms, innovation, restructuring and improvement
of people's well-being, according to the NBS.
The first-quarter growth exceeded market estimates of 7.3
percent.
However, it slowed compared to the 7.7-percent growth in the
fourth quarter of 2013, and marked the lowest quarterly growth level since the
third quarter of 2012. But even so, the figure still far outperformed the
6.6-percent growth in the first quarter of 2009, when the global financial
crisis wreaked havoc.During the same period, fixed asset investment growth gained 17.6
percent; retail sales expanded 12 percent, while the average per-capita
disposable income of both urban and rural residents grew 8.6 percent year on
year (China Daily, 2014) .
The economic slowdown came amid a generally mild inflation
rate in the first quarter, with the consumer price index, the main gauge of
inflation, rising 2.4 percent in March.Earlier data also showed the country's
exports and imports declined 1 percent year on year to $965.88 billion in the
first quarter while power consumption rose 5.4 percent year on year, though the
March figure picked up steam and rose 7.2 percent.
In China, imports and exports have contracted in the first
three months in spite of predictions at the start of the year that stronger US
and European demand would prop up slowing Chinese growth.
The services sector, which includes retail, made up 49
percent of gross domestic product in the first quarter, 4.1 percentage points more
than the industrial sector.Growth in retail bodes well for employment, a top
government priority, as services are now the biggest employer in China (Rose, 2014) .
As most countries tumbled into recession following the
collapse of Lehman Brothers in October 2008 China launched a massive state-led
building boom that propped up domestic growth and global demand, particularly
for commodities.But there is increasing evidence that China’s credit-fuelled,
investment-heavy growth model has now reached its limits.There are worrying
signs of overbuilding and oversupply in the Chinese real estate market, with
sales volumes and prices having already collapsed in many smaller cities.Real
estate construction accounted for as much as 16 per cent of GDP last year, a
level approaching that in Ireland or Spain before their housing bubbles burst.A
widespread property market crash would be devastating for Chinese investment,
which accounts for an unprecedented high level of about half of GDP (Anderlini,
2014) .
Beijing has announced some modest measures, such as tax cuts
for small firms and speeding up investment in railways, to try to steady growth
near its target of 7.5 percent without disrupting plans to restructure the
economy or worsening problems of overcapacity and debt.
Although the official GDP growth figure for 2014 will likely
be around 7.5 per cent, all of the economic momentum points downward. Export
growth will probably be very modest, because the US economic recovery has been
weaker than expected and the Chinese export sector is undergoing major
restructuring due to a rapidly rising cost base. The upward trend in
consumption should continue as rapid wage growth lifts household income, but
public consumption may remain soft as a result of the government’s
anti-corruption drive (Huang, 2014) .
Fixed asset investment is still the main area in which the
government acts to stabilise growth. But weakening market conditions in the
property sector mean the outlook is not encouraging. Manufacturing investment
should be relatively stable given the outlook for exports and consumption. The
central government may increase infrastructure investment if the economy
weakens again, but there is little room for local government action in this
area because of a decline in revenue from land sales and the tightening in
financing conditions for local government investment vehicles (LGIVs).
Recently, the central government started an experiment allowing ten provincial
governments to issue local government bonds (Huang, 2014) .
China PMI
China’s manufacturing sector continues to decline, at least
according to the latest PMI for manufacturing from Markit.1 The index moved
from 48.0 in March to 48.1 in April. A reading below 50.0 means declining
activity, so the index’s increase means that activity continued to decline, but
at a slightly slower pace. This was the fourth consecutive month of decline.
Separately, a Chinese government PMI for manufacturing indicates very modest
manufacturing growth in April. The index was 50.4, up from 50.3 in March. The
government index, separate from the better-known one issued by Markit, is
heavily weighted toward state-owned companies. This report still suggests
considerable weakness in the manufacturing sector. The subindex for export
orders was especially weak at 49.1, indicating a decline in such orders. Some
investors are hoping for more stimulatory measures by the Chinese central bank,
such as a cut in the reserve ratio for banks. Yet boosting credit market
activity is also risky because there may already be too much bad debt in the
system and there is certainly excess capacity in industry. A more sustainable
way to fix the economy would be to stimulate consumer spending rather than
debt-fueled fixed asset investment.
Shadow Banking
It appears that, despite government efforts to the contrary,
credit in the non-bank shadow banking system continues to rise rapidly. The
government reports that, in the first quarter, trust company assets were up 8
percent from a year earlier. The country’s trust companies now have assets of
11.7 trillion Chinese yuan, or $1.9 trillion—a record high. The average return
on trust assets has declined.
Recall that trust companies have been established to circumvent
restrictions on formal banking. The trusts lend money to private enterprises
(including property investors). They raise money by selling trust products to
private investors, usually offering a return far higher than is available
through formal banks. The trusts are often informally backed by banks. The
problem is that trusts have loaned money for many projects that are not
expected to generate positive returns. Increasingly, trusts could face trouble
meeting their obligations and may require help from banks. Banks, in turn,
could find themselves in trouble. Thus further growth of this shadow banking
activity is worrisome. Although it contributes to economic growth in the short
term, it creates more stress on the financial system in the longer run. It is thus
not a sustainable model for future economic growth.
Size and Outlook
For some time, we’ve known that China’s economy would
eventually overtake that of the United States. Most estimates had pointed to
the later years of this decade. Yet now the World Bank estimates that China’s
GDP will overtake that of the United States this year.
Two questions emerge: First, how is this determined? Second,
does it even matter?
First, for the purposes of this exercise, the World Bank
does not measure the size of China’s GDP at current exchange rates. If this
were to be done, the US economy would still be far larger than that of China.
Rather, the World Bank uses a “purchasing power parity” (PPP) exchange rate.
That is, it converts China’s local-currency GDP to US dollars using an exchange
rate that reflects the true purchasing power of the currency. How is this done?
The World Bank takes a large basket of goods and services for the United States
and determines the dollar price of this basket. Then it takes a similar basket
in China and determines its renminbi price. The ratio of the renminbi price to
the dollar price of this basket determines the PPP exchange rate. For example,
if the US basket costs $100 and the Chinese basket costs 350 yuan, then the
exchange rate is 350/100, or 3.5 yuan to the dollar—which is, in fact, roughly
the World Bank’s estimate of the PPP exchange rate. Keep in mind that the
current market exchange rate is roughly 6.2 yuan per dollar. The World Bank’s
new figures on GDP are based on new estimates of the composition and price of
that basket.
Second, does this matter? Not really. Clearly China has many
residents, and its economy has grown very rapidly in recent years. The fact
that it is now the world’s largest economy simply means that it generates
enough goods and services to match the purchasing power of the United States.
Yet China has four times as many people as the United States, so its per capita
output is thus one-quarter that of the United States. In other words, it has a
long way to go to match the living standards of affluent countries. Moreover,
for a variety of reasons, China’s growth is likely to slow down in the future.
Also, keep in mind that, at current exchange rates, the US economy is still far
larger than that of China. In terms of China’s participation in the global
economy, such as purchasing commodities and high-technology equipment from
other countries, China’s purchasing power still lags considerably. The measure
of GDP using a PPP exchange rate largely reflects the low prices of domestic services
in China. For example, the prices of haircuts, restaurant meals, and health
services are very low in China, thus effectively increasing the true purchasing
power of a Chinese wage. This is one of the principal reasons for China being
the “world’s largest” economy. From that perspective, the label is not very
meaningful (Kalish, 2014) .
Conclusion
There is increasing evidence that China’s credit-fueled, investment-heavy growth model has now reached its limits.There are worrying signs of overbuilding and oversupply in the Chinese real estate market, with sales volumes and prices having already collapsed in many smaller cities.Real estate construction accounted for as much as 16 per cent of GDP last year, a level indicating a possible housing bubbles about to burst.A widespread property market crash would be devastating for Chinese investment, which accounts for an unprecedented high level of about half of GDP. The manufacturing sectors still remains frail.Some investors are hoping for more stimulatory measures by the Chinese central bank, such as a cut in the reserve ratio for banks. Yet boosting credit market activity is also risky because there may already be too much bad debt in the system and there is certainly excess capacity in industry as evidenced by the shadow banks. A more sustainable way to fix the economy would be to stimulate consumer spending rather than debt-fueled fixed asset investment.Thus further growth of the shadow banking activity is worrisome. Although it contributes to economic growth in the short term, it creates more stress on the financial system in the longer run. It is thus a short term effective method but not a sustainable model for future economic growth.As the World Bank estimates that China’s GDP will overtake that of the United States this year this statistic has to be put in context as it is calculated using purchasing power of parity which underscores suggestions that China's renminbi is still undervalued. China still lags in terms of per capita income as well as standard of living but this should not discredit the Chinese government as its sound economic management polices cushioning the Chinese economy for a safe landing have proved bold in uncharted territory. We cannot take away from what is apparently clear to be an unprecedented economic growth management model. It may have it flaws but overall it is still a decent role model for developing nations.
Some Economist projections estimate China's economy will grow by 7.4% in 2014 just a tenth of a percentage point below the Chinese government projection of 7.5%. I project a growth of 7.6% on the anticipation of strong domestic consumption as Beijing might stimulate the economy by cutting reserve ratios to get an inflation rate much closer to its yearly target.
References
Anderlini, J. (2014, April 16). Slowing growth
adds to China stimulus pressure. Retrieved June 17, 2014, from Financial
times:
http://www.ft.com/cms/s/0/ea52d1c6-c507-11e3-8dd4-00144feabdc0.html#axzz34uINUyuX
China Daily. (2014, April 16). China's first
quarter GDP grows 7.4%. Retrieved June 17, 2014, from China Daily:
http://www.chinadaily.com.cn/business/chinadata/2014-04/16/content_17437546.htm
Huang, Y. (2014, June 15). Where will the Chinese
economy land? Retrieved June 17, 2014, from East Asia Forum:
http://www.eastasiaforum.org/2014/06/15/where-will-the-chinese-economy-land/
Kalish, I. (2014, May 21). Asia Pacific Economic
Outlook, June 2014: China. Retrieved June 17, 2014, from Dupress:
http://dupress.com/articles/asia-pacific-economic-outlook-june-2014-china-2/
Rose, A. (2014, April 16). China economic growth
slows to 18-month low in first-quarter. Retrieved June 17, 2014, from
Reuters:
http://www.reuters.com/article/2014/04/16/us-china-economy-gdp-idUSBREA3F04J20140416
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