China’s Modest Credit Stimulus Should End Talk Of A Hard Landing by Andy Rothman, Matthews Asia
A modest credit stimulus and a housing market rebound led to a pick-up in investment and industrial activity during the first quarter of the year, and while that should end talk of a hard landing, the gradual deceleration of China’s economic growth will continue. Growth is driven increasingly by consumption and services as rebalancing proceeds, and that part of the economy—the largest part—continues to offer opportunities for investors.
A Modest Credit Stimulus
Concerned that the industrial and investment parts of the economy were slowing too much, the Chinese government delivered a modest credit stimulus in recent months by boosting bond issuance targeted at public infrastructure projects. As a result, investment in infrastructure rose about 21.6% year-over-year (YoY) in March, up from 17.1% during the first two months of the year but roughly the same as the 22.1% pace of the first quarter of last year. The limited scale of the stimulus was also reflected in a 10.7% growth rate for total fixed asset investment for 1Q16, down from 13.5% during the first quarter of last year.
This modest credit stimulus helped stabilize growth and should eliminate talk of a hard landing, but there is no reason to expect a reacceleration of the Chinese economy. The stimulus was only large enough to put a floor under growth and figure 1 illustrates that while GDP growth of 6.7% is a fast pace relative to almost any other country, it has been decelerating for several years.
And having achieved their objective of stabilization, I think it is likely that the government will reduce the level of stimulus by the end of the year, and I expect growth to continue down the path of gradual deceleration.
Consumers and Services Remain Robust
It is important to note that while the credit stimulus stabilized the industrial part of the Chinese economy, the services and consumption part continues to thrive without extra help, based on strong income growth and low household debt.
Electricity consumption by the services and consumer (tertiary) part of the economy jumped by almost 11% during 1Q16, while power consumption by industry (the secondary part) was flat on a YoY basis.
While China remains the world’s best consumption story, YoY growth rates are decelerating here too. Following a decade in which real (inflation-adjusted) income rose 130% (compared to 11% in the U.S.), real urban income increased 5.8% in 1Q16, compared to 7% a year ago. Real rural income rose 7%, down from 8.9%.
As a result, while real retail sales growth was still fast at 9.6% during the first quarter, it was down from 10.7% a year ago.
The slightly slower pace of income growth still leaves Chinese consumers feeling quite optimistic, according to a McKinsey survey of households. Fifty-five percent of respondents said they expect their income to increase significantly in the next five years, on par with the 57% result in a 2012 version of the same survey.
That optimism is clear from results of some foreign firms selling to Chinese consumers. In the first two months of this year, Mercedes reported a 43% rise in vehicle sales, while Ford’s sales rose 18%. In their most recent quarter, Nike’s greater China shoe sales rose 33% and Apple sales were up 14%.
A healthy consumer is especially important because this is likely to be the fifth consecutive year in which the services and consumption (tertiary) part of the economy will be larger than the industrial (secondary) part. This “rebalancing” process continued during the first quarter, with the tertiary part accounting for 57% of GDP, up from just over half in 2015, and 41% in 2005.
From another perspective, consumption accounted for two-thirds of China’s GDP growth last year, a share that is likely to be even larger this year. That’s the part of the Chinese economy—the largest and fastest growing part—where our investment strategies are focused.
New Home Sales Rebound
The housing market is another reflection of consumer health and optimism, with residential floor space sold up 30-40% in each of the first three months of this year, compared to YoY declines during the same periods in 2015 and 2014. As a result, new home starts rose 14.8% during the first quarter, and investment in the residential sector was up 7.8% in March, compared to growth of only 0.4% during all of last year.
About 90% of new home sales are to owner-occupiers, and this year’s rebound has been stimulated by government policy: the minimum cash downpayment was cut to 20% from 30%, and at 4.9% the benchmark lending rate is about 25% lower than it was two years ago.
In addition to a slightly looser monetary policy, fiscal spending increased 15% during 1Q16, up from 8% a year ago and 13% two years ago. The fiscal focus has been on what I call “soft” infrastructure, with double-digit increases in spending on education, social security, health care and low-income housing.
Less Anxiety, Hopefully More Restructuring
In my view, the main success of the first quarter has been in reducing anxiety about the health of the Chinese economy. Stability in the industrial sector should curtail fears of a hard landing. Last month’s increase in foreign exchange reserves has already curbed talk of capital flight. A cautious U.S Federal Reserve led to a weaker U.S. dollar, which led the Chinese currency to appreciate a bit, blunting fears of a dramatic devaluation. And, at the same time, the consumer and services sector remained robust.
Hopefully, this reduction in anxiety will provide an opportunity for Beijing to press ahead with further restructuring of the state sector. There was some progress last year, with the reduction of 5.8 million industrial jobs, including 400,000 workers cut in both the coal and steel industries, but much more needs to be done. The services sector has created all net new jobs in China in recent years, so additional industrial restructuring can be done without threatening the health of the consumer story. And more cuts to state-owned firms will increase opportunities for the privately-owned companies which already employ more than 80% of the urban workforce and which are far more successful. During the first two months of the year, profits at privately owned larger industrials rose 7.5% while profits at state-owned industrials fell 14.5%.
Andy Rothman
Investment Strategist
Matthews Asia
As of March 31, 2016, accounts managed by Matthews Asia did not hold positions in Daimler AG, which owns Mercedes, Ford Motor Companies, Nike., Inc. and Apple, Inc.
*Industries defined as:
Primary industry refers to agriculture, forestry, animal husbandry and fishery and services in support of these industries
Secondary industry refers to mining and quarrying, manufacturing, production and supply of electricity, water and gas, and construction
Tertiary industry refers to all other economic activities not included in the primary or secondary industries, including real estate, finance, wholesale and retail, transportation and other service industries
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect the writer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general.
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