China’s Growth: Warning Signs Increase by Anthony Chan
China’s July economic activity data was alarmingly sluggish—reinforcing our cautious view on China’s growth. For investors who think the Chinese economy is stabilizing, July’s warning signals may serve as a wake-up call and, we believe, could trigger a repricing of China risk.
The latest data on China’s economy have underscored worrisome concerns about its gross domestic product (GDP) outlook for the second half of 2016 and 2017. Among the downbeat data were some eye-poppingly alarming trends. Fixed asset investment (FAI) continues to decline, dropping significantly to just 3.9% growth year over year, which is a marked slowdown from June’s 7.3% level. Private FAI tumbled by 1.2% year over year—an unheard of contraction.
Although the FAI for China’s state-owned enterprises grew 14.4% year over year, that simply confirms our view that public investment (mostly on infrastructure) is the only participant remaining in China’s economic growth (Display). And that one player is insufficient to prop up China’s GDP, since housing and manufacturing investment have waned, and export growth, once again, has contracted.
In fact, the housing market is looking notably grim. The trends in 2016 for both land sales and housing starts have been increasingly negative, and transactions are slipping down from their previously high levels. All of this corroborates our long-held view that we will likely see a more meaningful housing market correction in the second half of 2016.
Along with that, retail sales are easing further. The earlier uptrend in the housing market that began in 2015 has uncharacteristically failed to lift consumption. The bottom line is that with wages and household income slowing, consumption growth is also waning.
Unclear Monetary and Economic Policy: Growth’s Underlying Ailment
The key element that is hobbling any new business initiatives is the government’s murky policy directive. Uncertainty has made everyone pause as they await some clarity. The government has previously pumped too much liquidity into the economy, which did little to revive private investment or demand. Some of the liquidity supported the government’s never-ending public infrastructure investment, but the bulk has been pumped into a succession of speculative purposes in search of some returns—from housing, to equities to bonds, to commodities…and then back to housing, etc.
On top of these domestic liquidity flows, we’re seeing an increasing trend by domestic investors to use the Chinese yuan, or renminbi, as a funding currency: as local rates fall the government has used the renminbi to purchase the US dollar–denominated offshore bonds issued by many Chinese corporations.
One unlikely scenario going forward would be a tightening of the liquidity tap. In that case, it is the asset side of China’s balance sheet that will start to shrink but not the real activity side. That’s because the real activity side hasn’t been growing much in the recent past.
What’s more likely to unfold is that the current policy vacuum will allow officials to continue letting economic activity slip rather than prompting them to come up with some urgent reflation policies. In the past, the scenario of increased policy easing was almost a sure thing. But nowadays, that’s not as certain an outcome. At some point, there may be some bolder policy responses from the top. But the risk is that China may again embark on a wrong path. For example, the government may inject more liquidity, priming the economy with big fiscal numbers and traditional means, or bailing out ineffective state-owned enterprises, but avoiding necessary reform or restructuring pains. In other words, the government would likely resort to the same mode of “command and control.”
All the uncertainty and weakening data leads us to forecast only 5.6% growth for China’s GDP in 2017, as we believe that the data over the next few months will show a marked deceleration for the second half of 2016.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.