The last several days saw the release of the usual slue of monthly and quarterly economic stats out of China, which were mostly met with applause from the financial punditry as headline numbers beat expectations. A look under the hood, however, reveals quite a different story. The composition of growth in China again markedly deteriorated in the second quarter as did the debt dynamics. It appears the government is making every effort to prop up the slowing economy at any cost and with lower and lower marginal returns. The technical term is “pushing on a string”.
Real second quarter GDP grew 6.7% year-over-year, beating expectations of 6.6% growth. Nominal GDP, on the other hand, grew 7.2% and marked the second consecutive quarter of faster growth.
So far so good, except that total social financing grew by 14.3% year-over-year, further pushing up the ratio of total social financing as a percent of GDP to an all-time high of 1.44. With the stock of loans nearly 1.5x that of the level of nominal GDP and the former growing at twice the rate of the latter, the difference between the two series is growing exponentially wider, as the second chart below shows.
Another lauded stat was the growth in fixed asset investment. It came in at 9% vs expectations of 9.6%, but that’s OK because everyone knows fixed asset investment growth must slow, right? Well yes, it must slow to low single digit growth or eventually turn negative so that consumption as a percent of GDP can rise to a more normal level. Yet, the composition of fixed asset investment is downright abysmal. State owned enterprise fixed asset investment growth was +23.5% year-over-year, the fastest since 2010, while private sector growth is making a b-line toward zero.
Wholesale and retail sales grew 10.6% YTD through June compared to expectations of 10%, led in large part by auto sales growing at an 11% clip YTD. On the surface, those are good stats and when taken with headline fixed asset investment suggests that China is finally rebalancing it’s economy. Yet, we must remember that this is in large part due to the significant fiscal stimulus geared toward boosting auto sales, which account for 25% of retail sales. Once incentives go away, auto sales, and retail sales with them, will likely begin slowing again.
And all that fits nicely with central government spending as a percent of GDP having exploded to 27%, which is fully 4 percentage points higher than a year ago and well into all-time high territory.
Furthermore, M1 growth is making a moonshot, growing 25% year-over-year and at the fastest rate since China’s enormous stimulus package following the financial crisis. From the above, it’s very likely that China is pumping the economy full of liquidity to support loan rollovers and further infrastructure investment by the SOEs.
So all in all it appears we’ve moved into a new phase of the China slowdown story. Private investment growth, by far the largest driver of growth over the last decade, has started to slow markedly and the government has stepped in to cover most of the shortfall through state directed finance and an unprecedented pickup in government spending. Far from being a symbol of stability in China, this all points to more fragility and the even greater potential for a faster slowdown in the quarters ahead as fiscal stimulus ceases to be a tailwind.