According to ‘experts’ China needs to grow at a rate of at least 7 percent per year to avoid unrest. China grew well above this level in the past several years, however, this year forecasts are coming close to that level, with many analysts predicting GDP growth of 7.4%. Indeed, just yesterday, riots which occurred in Western China left at least 27 dead.
However, according to Andrew Garthwaite of Credit Suisse we might soon get below that level. In a new report he predicts GDP growth of just 6%. Certain sections of the report can be found below. One saving grace, Andrew says it will take ‘several years’ before China gets to the 6% level, but does not specify a timeframe. It could very well be that the number is just picked out of a hat and/or Chinese will reach 6% slow enough to avoid social chaos.
Our Concerns About China
- We are bears of China GDP growth medium term: high leverage, slowing sensitivity of growth to leverage, de facto tightening, housing looks a bubble, infrastructure investment is already running at 20% YoY, labour force has contacted last year, wage growth is picking up & the real cost of capital has turned positive. In year one of a 10 year term, reform likely to be preferred to growth! We would not be surprised if Chinese trend GDP growth eased to 6%.
- However, we don’t think Chinese GDP growth will fall below 6%, over the next year, as: government debt-to-GDP is 72% (nominal rates are below nominal GDP growth), loan-to-deposit ratio in banking system is still 72% and mortgage debt-to-GDP is one third of US levels.
- Chinese GDP growth below 6% would be a problem for global markets. Up to that level, the fall in commodity prices might help developed market GDP growth, reduce inflation (which makes central banks more stimulatory) and postpone Fed tapering. Limiting overcapacity might also help some of those industries where China has over-expanded (solar, wind, aluminium etc).
- Investment conclusions (Slide 14 to Slide 28): our preferred China-related shorts are mining, steel, mining equipment, the Australian dollar and domestic Australia. We think that the China consumer should be resilient: with the consumer share of GDP at half the levels of those in the US, c12% Chinese discretionary consumption growth is possible even in a lower growth environment. That said, we are underweight food producers and tobacco, on the back of worries about earnings momentum, positioning and valuations.
Total leverage is around 230% of GDP. Half of new loans in the last year have come from the shadow banking system. Total government debt is 72% of GDP (including all off balance sheet lending by local government), compared to an official figure of 15% of GDP. The local government’s deficit is 8.5% of GDP, compared to the central government’s deficit of 2%of GDP. Shibor lending rates have recently spiked.
Growth is becoming even more imbalanced: China’s investment share of GDP is now at 48%, 10 percentage points higher than any other country has had in recent history. In the decade after investment share of GDP peaked in other industrializing countries, GDP growth fell by between a quarter and a half.
When did a housing bubble not end in a bust? However, there are some differences in China:
- There is not a lot of consumer debt in housing. Total mortgage debt-to-GDP is 18% (compared to 76% of GDP in the US in 2006) – and corporate debt in property is only 13% of GDP.
- Banks will continue to lend: the typical loan-to-value ratio on home-related loans is 50%; banks’ loan-to-deposit ratio, at 71%, is low; in 2004, banks were recapitalised using FX reserves (which stand at 45% of GDP), and banks lend when they are told to lend.
- Social housing completions should rise (from 5m to 6m in 2013), though social housing starts fall from 10m in 2011 to 7m in 2013.
- Our worry is the proportion of local government revenue from housing/ property development (expropriation of land)….30% to 40%.
H/T V. Phani Kumar