Sent: 18-07-2013 10:52:02
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Growth Slowdown Signals China Joining the Pack
Chinese growth was always going to slow. Having to reduce the contribution of investment spending to GDP from as much as 50% to something closer to 35% made this almost certain. Now, ironically for a formerly centrally planned economy, growth outcomes depend increasingly on the short term management skills of central government policymakers as the non government forces that drove Chinese growth for over a decade peter out.
China reported its GDP growth for the second quarter this week. Chinese growth statistics are quickly becoming as much of a focal point for markets as those from the USA although the quality of the Chinese statistics remains vastly inferior to those produced by the US Bureau of Economic Analysis.
Many of the Chinese macro numbers are based on very simple sampling techniques covering only larger companies and selected industrial sectors. For many analysts, consequently, the best guide to what is happening remains some of the individual sectoral statistics like steel production, car sales and electricity usage.
Importantly for Australia, the Chinese data released on Monday confirmed still strong growth in steel output. The comments for 5 July in my daily market diary (http://www.eimcapital.com.au/PortfolioDirect/daily_views.htm) put the apparent slowdown in Chinese steel production into perspective.
At 1.7% for the quarter and 7.5% over the year to June, the GDP growth rate was consistent with what the government had said it was aiming to achieve. This was a relief for markets increasingly fearful of growth falling short of the government's target.
Only a few days before, finance minister Lou Jiwei had seemed to guide expectations lower when he was reported as saying that growth as low as 6.5% would be acceptable. This came shortly after fears of a credit crunch due to a spike in lending rates in the Shanghai banking market. The sharp swing appeared to have the endorsement of a central bank trying to take the heat out of speculative lending before it backtracked once the potential severity of the move became apparent.
One of the challenges for the Chinese government is to meet the public's social and political demands for higher living standards while using its large but limited capital resources less wastefully. Poor investment practices, fed by loose lending criteria, have boosted growth in the short term but have begun to jeopardise financial stability leading to doubts about the government achieving its broader aims.
The government is facing down these threats. Monday's statement from China's National Bureau of Statistics did not mince words nor did it feign the objectivity coveted by western statistical agencies.
The NBS referred directly in the English translation of its statement on the GDP statistics to "the complicated and volatile economic environment at home and abroad". Elsewhere in its statement, the statistics agency described the country as being "faced with grim and complicated economic situations". This hardly sounds like the growth engine for the world economy so many had come to expect.
Ministers are letting everyone know that rebalancing the economy to improve the quality of economic growth (i.e. boosting the contribution to growth of consumption at the expense of investment) is, along with stamping out corruption, one of the highest priorities for the government. Environmental concerns are also looming large with an increasingly restive population prepared to express its views in the streets about the quality of the air and, recently, the risks attaching to a 37 billion yuan uranium processing plant covering 229 hectares near Heshan. The uranium proposal appears to have been abandoned after "opposition from every level of society", according to a local government statement.
Seemingly unstoppable double digit growth rates bringing unequivocal improvements in living standards have morphed into more ambivalent gains that have come with growing financial risks.
In launching its revised global economic forecasts last week, the International Monetary Fund joined those warning about the need for China to wean itself off its credit fuelled investment binge. At the same time, the Fund's head of economic research clearly stated his belief that Chinese policymakers were on top of the job having anticipated the need to make the policy changes now underway.
News reports from China refer to lobbying by local government entities whose viability is being threatened by tightening credit controls. The central government will have to assess whether some Chinese local authorities and their financiers are too big to fail or whether they could have systemically weakened the financial system by enough to threaten bigger institutions.
In some respects, the current Chinese predicament resembles the US savings and loan crisis from the 1980s. Individual business risks appeared to be of little consequence to the national economy but bad lending practices became so widespread they eventually jeopardised the stability of the financial system.
With the benefit of hindsight, we can see that much of the growth impetus over the past 20 years came from the economic freedom unleashed by reforms in the late 1980s and early 1990s. In permitting privatisation of industry and the removal of price controls, those reforms freed pent up consumer and investment demand contributing to a lengthy period of spectacular growth.
The initial explosive burst of entrepreneurial spirit coinciding with government bodies and regional politicians competing to demonstrate their own development credentials could only happen once. Eventually, there is a physical limit to the number of bridges needed to cross rivers, the number of apartment buildings and even the number of cars that can fit on rapidly expanding lengths of roadway.
Now China has to confront the limits to its growth. Even with generalised wage increases running at 14% a year, consumption spending cannot compensate fully for reduced investment spending that had accounted for as much as 50% of national output.
If 40-50% of the economy is contracting, the balance has to be growing very fast to get near 7% a year for the whole. With weakening growth elsewhere in the world, the task for an export oriented economy also becomes substantially harder.
Over time, the benefit of high wages also becomes less clear-cut. Higher wages support demand but reduce business competitiveness and raise the risk of institutionalising inflation.
China is losing competitiveness not only as its wages rise but as European economies restructure, US manufacturers take advantage of cheap energy, low interest rates and a weaker currency and other emerging economies more aggressively seek to develop their own manufacturing bases.
As these changes occur, China begins to look like any other large economy insofar as it comes to rely on short term government policy and carefully targeted incentives to direct activity at the margin and avoid potentially destabilising habits.
Even well explained policy can create volatility, rather than reduce it, as policymakers grapple with sometimes conflicting goals amid uncertain and changing responses by consumers and business in market economies. This has been the experience elsewhere.
In Frankfurt and London and Washington and Tokyo, where the skills and judgements of those at the helm can make a difference, the same questions are being asked about the effectiveness of policy and, now, Beijing seems to have been added to this group.
China is becoming just like everywhere else. There was no reason to expect anything different. The one-way bet has been removed. Trying to guess policy outcomes in yet another major economy is an additional challenge now facing investors as they contemplate prospects in the year ahead.
(John Robertson is a director of E.I.M. Capital Managers, a Melbourne-based funds management group. He has worked as a policy economist, corporate business strategist and investment market professional for over 30 years after starting his career as a federal treasury economist in Canberra. His daily Market Diary - Brief Thoughts on Current Issues is available at http://www.eimcapital.com.au/PortfolioDirect/daily_views.htm).
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