Strong growth in investment, property prices & credit has seen moves to slow Chinese growth.
China is moving to slow excessive growth in credit, money supply and investment and to cool property markets in some cities. Further moves seem likely in the months ahead. This is naturally leading to concern about the outlook for the Chinese economy, with some foreseeing a major downturn and others seeing a soft landing. None of this is new. We saw it all before back in 2004 when the Chinese authorities last embarked on a round of tightening measures. We remain in the soft landing camp.
Recent history and the current problem
In 2003-04 there were signs that the Chinese economy was overheating – money supply and credit growth was going through the roof, investment was booming with clear signs of overinvestment in some areas, there were infrastructure shortages and property prices were surging in Shanghai. As a result monetary conditions were tightened via increased reserve requirements and lending rates and capital requirements for a range of overheating industries. While fears grew of a hard landing, it did not eventuate – growth was 9.9% in 2005 thanks to stronger exports but there was a rebalancing away from investment, inflation fell and a bubble in the Shanghai property market burst.
More recently though, concerns have returned with news that GDP growth for the year to the March quarter was 10.2%, growth in fixed asset investment has accelerated back to near 30% (see the next chart), money supply growth is running around 19%, loan growth is running around 15% and property markets in various cities like Beijing seem to be booming. Income disparities between the east coast cities and inland regions and between rural and urban areas have also become a concern.
As a result, talk of rebalancing growth (from investment to consumer spending and from a focus on the east coast cities towards inland areas) was followed by official concern about excessive growth which was followed by an interest rate hike in late April, various measures to slow property markets and controls on new investments. More measures are likely including further moves on interest rates, increased bank reserve requirements which will slow the ability of banks to make new loans and possibly a faster rate of appreciation of the Renminbi against the $US. As was the case in 2004, many worry that this will result in a hard landing for the Chinese economy. China’s rapid urban labour force growth as workers leave rural areas and strong productivity growth mean that its potential real growth rate is at least 8% pa. As a result, a hard landing would occur if growth slowed to say 6% pa or below. A soft landing would see growth around 8 to 9% pa.
We still don’t see a hard landing
As with 2004, the risks of a hard landing can’t be ignored as economic management is less well developed in China than in developed economies. The uncertainty is made greater by the often conflicting nature of policy statements and their repackaging. This adds to the risk of going too far. But we are of the view that a soft landing is most likely. Firstly, there are no signs the Chinese economy as a whole is overheating, which is the normal precursor for a hard landing:
· Inflation remains benign and significantly below the levels it reached in the late 1980s and mid 1990s, which resulted in aggressive moves to the slow the economy followed by a sharp downturn in growth. Although Chinese inflation is likely to drift up this year reflecting pricing reforms (eg, higher utility charges and petrol prices) and a lagged response to the recent rise in money supply growth, it is still likely to remain low at around 3% pa.
· Fixed asset investment is not as strong as it looks. In real terms it is estimated to be growing at 14% year on year. Construction and infrastructure spending are really just picking up after a soft patch in 2004-05.
· As in 2004, residential property prices are mixed. While Beijing and Shenzhen are seeing strong conditions, the Shanghai property market has gone from boom in 2003-04 to now bust.
· Industrial profit growth is just recovering from a sharp slowdown and profit margins are below 2004 levels.
· Growth in retail sales and imports do not show any acceleration in growth.
· Overheating is normally associated with a trade deficit blow out, but China has a large trade surplus.
China is certainly on a far sounder footing than the pre-1987 “Asian miracle” economies – with a large trade surplus it is not reliant on foreign capital inflow, it has low foreign debt, has significant foreign exchange reserves and has an undervalued currency.
Finally, the Chinese authorities do not appear to be seeking a major slowdown, but rather are looking to take the edge off overheating sectors and to rebalance growth towards consumer spending and inland areas. The later will be hard to achieve if the economy slows too much as would the absorption of the 15 million or so people who are leaving the rural sector each year. The relative stability of China’s GDP growth rate over the last decade along with the 2004 experience suggests that they have a reasonable chance of being successful. So overall we see Chinese growth slowing back to around 8.5% to 9% this year, as growth in fixed asset investment and exports slows but consumer spending speeds up a notch.
Key China themes
Broadly speaking we see the following key China themes[1]:
Theme #1 Growth to slow, but not collapse – as above.
Theme #2 Expect more consumption, less investment China’s Government has made boosting consumption a key priority. Policies to encourage consumption include pay rises for public employees, tax cuts and measures to boost rural consumption.
Theme #3 Excess capacity in the manufacturing sector
After years of strong investment, China’s manufacturing sector is suffering from excess capacity in some areas.This will ensure ongoing downward pressure on global consumer goods inflation. While wages are rising rapidly in China from a low starting point, strong productivity gains and China’s scale advantages mean that China will retain its competitive advantage for many years to come.
Theme #4 Long term growth outlook is very positive
The key drivers of China’s long term growth remain intact and are set to drive continued strong growth for many years. If China grows at 8% pa it will take 30 years or more for China’s current per capita income to catch up with Australian levels. The China growth story has a long way to go.
Theme #5 The Renminbi will steadily appreciate
Since the one-off 2.1% revaluation of the Renminbi against the $US in July last year, the Chinese currency has appreciated by a further 1.2%. By the end of 2006, it is likely to have appreciated by another 3%. However, this is won’t have much of an impact on Chinese exports.
Theme #6 Positive outlook for China A shares
Last year marked a major bottom in Chinese mainland shares (‘A’ shares), which had been in decline since 2001 due to overvaluation and fears that a flood of shares held by the public sector would be sold. By last year, ‘A’ shares had fallen back to reasonable valuations, a slump in profits had already been factored in, the stock overhang problem was being resolved, foreign participation was steadily rising adding to market depth and maturity and a gradually rising Renminbi was seen as adding to the market’s attractiveness. So far this year Chinese ‘A’ shares are amongst the world’s strongest with an increase of 40% – and we see further gains ahead.
Conclusion
Like all emerging countries, China faces significant risks and hurdles which result in a volatile ride every so often. While Chinese growth is likely to slow this year, resulting in some short term nervousness about the outlook for commodity demand and hence resources shares, it should still remain solid. The industrialisation phase in China’s development cycle, which is likely to last for a generation, will be associated with continued strong demand for industrial commodities and augurs well for Australian resource shares over the longer term.
By Dr Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors.*
[1] See “China in 2006 – key themes”, Oliver’s Insights, December 2006 for a more detailed discussion of these themes.
