Parsing the Chinese Hard Landing
China released a raft of economic data today – all of which – as expected, show that output stalled on a quarterly basis and actually contracted in the fourth quarter of 2008. This is consistent with the outlook we depicted in the RGE Global outlook – available this week to premium subscribers – in which we argued that the that global demand for Chinese goods will remain weak through 2009, that government investment will only partly offset the decline in corporate capital expenditure and that property investment and consumption will weaken – leading to GDP growth of 5% or less in 2009.
As Nouriel notes it was also consistent with other previously released data; the OECD leading indicator for China was second only to Russia in the steepness of its decline portending further ills ahead, electricity output (a proxy for GDP) has contracted, investment both from domestic and foreign sources is slowing, exports are contracting, property prices are falling and retail sales are slowing – all in all signs of a slump.
On an annualized basis Chinese growth slipped to 6.8% about half the 2007 rate. But on a seasonally adjusted q/q basis Chinese growth contracted in Q4, by about 0.3% according to Citigroup, which they suggest was the first quarterly contraction in 16 years. As China revised how it calculates its GDP in 2005 and hasn’t released revised historical data it is hard to compare, of course. But for an economy used to growing at approximately 10% annually, the current trajectory is painful – job losses are accelerated, consumption is slipping, although government pressure on the banks to lend may support some investment and money growth in 2009.
China is facing at least two simultaneous slowdowns that are now reinforcing each other despite government intervention. The first was domestic – when attempts to cool the investment boom which was overly concentrated in property (20% of Urban fixed asset investment) contributed to a decline in sales and prices in key markets, especially the most overheated ones. Investment has now cooled (marking about 26% for 2008 as a whole but slowing to under 22% in December from around 29% as recently as September). And Investment growth is slower on the coastal regions which previously boomed. While it is true that the fiscal stimulus remains to be implemented (which will begin occurring over the next few months), despite its size, the existing plans may find it difficult to offset the ongoing slump – Check the RGE Global Outlook for more on this.
The sharp slowing and now contraction in the Chinese export sector, especially the low cost processing trade was somewhat lagged. An increase in exports to Europe and emerging markets (in part because of exchange rate effects) partly offset the decline in demand from the US as the US consumer faltered and inflation and a somewhat higher RMB led to lower demand from the US. However mid 2008 from that point the synchronized drop in demand along with the collapse in trade finance which hit Asian exports hardest, eliminated this prop. Chinese exports contracted in November and December, a trend that will likely continue through much of 2009. However, imports contracted more, meaning that net exports will continue to add to growth, but not from a sign of strength. Given that China now sources a greater share of export inputs at home, not abroad, its exposure to global demand is even greater than it was even three years ago. With a 2009 contraction in global exports, Chinese exports will find it hard to pick up.
Although net exports make up only around 20% of GDP – the export related capital expenditure is much higher and even the distribution chain to more domestic consumption is difficult as export rebates create disincentives to sell at home. Meanwhile the Chinese consumer is faltering somewhat too – Retail sales have been slowing for about three months now – growing only 19% in December from almost 21% in November and over 22% in October. Chinese retail sales do not include services which are likely suffering more than goods purchases. Furthermore, urban consumption is slipping more rapidly than those in rural areas as job losses hit – with urban consumers making up 75% of the total and their larger, albeit likely diminished salaries, purchases will also slow.
So what does this all mean for China? There are some signs of relative stabilization over the next few quarters, but we feel these would reflect the absorption of still high inventories and may only pave the way for further slowing in output given that the global economy and demand for Chinese goods will remain very sluggish. The realization that the combination of the destocking bounce and government fiscal stimulus might take longer to return China to trend growth is leading key analysts to revise downward their growth estimates. Its actually a matter of interesting debate if China will return to its past trend when expansion resumes, a more consumption-driven economy and lower if still ample global liquidity could lead to a lower potential growth rate (but more on that later). Morgan Stanley cut its growth outlook to 5.5% from 7.5% earlier this week and Citigroup lowered its estimate to 7.6% from 8.2% (as a comparison Goldman Sachs December forecast suggested 6% and RGE suggests 5% at best). Increasingly even government officials are acknowledging that it may be difficult to achieve the target 8% thought to be needed to continue to create jobs. Given the increase in unemployment both among factory workers and university graduates, this is a key government priority.
So all signs point to a further sharp contraction in Q1 and possibly Q2, with some stabilization. But absent some, albeit sluggish, increase in US demand, China can’t grow very much. In fact, the chance of a W-shaped growth trajectory has increased in which Chinese growth continues to slow sharply on an annual basis through much of H1, followed by some stabilization as inventories are worn off and the Chinese stimulus provides a slight boost, followed by a further declines later in the year on sluggish global demand.
The government has been quite aggressive in its monetary and fiscal response and Chinese money growth and loans have been on the increase in December. But the banks are still wary of lending and it is still difficult for SMEs to get access to credit. Moreover, as Michael Pettis and Victor Shih notes, the extension of credit poses other future risks, an increase in loan defaults as one returns to policy-based loans, an increase in bank (and government liabilities). China may well need to use more of its reserves to support its banks. Nicholas Lardy already argued that the recapitalization of the Agricultural bank of China and similar operations may have accounted for some $100 billion of the assumed capital outflow in the fourth quarter.
The Chinese government does continue to announce a range of stimulus responses – however with the bulk of it coming in infrastructure – including some earthquake and railway construction already planned, it may have limited effect on boosting consumption and offsetting the decline in other investment. China has also been trying to boost the auto sector by introducing tax incentives and the steel sector by cutting production. But the assumption that these responses will kick in by March and cause a V-shaped recovery by Q3 seem somewhat over optimistic.
So this all means, Chinese demand growth for commodities mig
ht continue to be weaker than it has been in 2005-mid2008. And its demand for US assets may also downshift from past peaks. Already China is one of many sovereign investors privileging liquidity, contributing to demands for short-term US assets. But the Chinese surplus and US overall deficit are both expected to be smaller in 2009 than in 2008. All of this changes but does not eliminate the co-dependency between the US and China.
Finally a note on the accuracy of Chinese economic statistics. Overall, these seem to have improved, especially for those statistics that can be independently verified like those of trade and even inflation. Money growth also. Industrial production though is still thought to be suspect at least on a monthly basis. The test may come in the coming months. Already local officials have wavered between confirming or denying large job losses. However, the hope of attracting more government funds may have increased the incentive to release such data.
Yet most China analysts use a series of proxy figures to assess growth. with electricity production being the most common. In the last slowdown electricity production – in this case, in China and elsewhere in the world the energy-guzzling heavy industry has been among the most vulnerable, contributing to a drop in electricity demand and in demand for carbon credits. For one thing, China tends to report many economic figures quite quickly and for a large dynamic economy this may add to the need for revisions.
Whatever metric one uses, it doesn’t seem like a happy new year.
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Treasury Secretary Timothy Geithner hasn’t even moved into his Washington DC office yet, but is already scapegoating the Chinese for US Financial problems.http://www.bloomberg.com/apps/news?pid=20601087&sid=aglY3XdKiWp0&refer=homeJan. 22 (Bloomberg) — Timothy Geithner, President Barack Obama’s nominee for Treasury secretary, said the new U.S. administration believes China is “manipulating” its currency.Geithner also said, in written responses to questions from Senate Finance Committee members, that there are “no current plans” to request more financial-bailout funds. He played down any need to nationalize U.S. banks, without specifically ruling out the option.The remarks on China’s exchange-rate policy may presage a tougher hardline with the nation that is the biggest foreign investor in U.S. government debt.The U.S. China Business Council, which represents large exporters such as Caterpillar Inc., Cargill Inc. and Ford Motor Co., has urged the U.S. to refrain from sanctioning China through legislation and instead to continue the Bush administration’s effort to engage America’s second-largest trading partner.“A single-minded focus on China’s currency is a distraction,” the group said in a report on Jan. 14. “China’s exchange rate is not the significant factor in the bilateral trade balance many make it out to be.”
There is actually a pretty strong consensus among china analysts that ABC didn’t account for slow reserve growth in q4. Dr. Lardy now shares that view; repatriation of profits by foreign firms looks to have been more important source of outflows but even that looks too small to explain the full fall.
Chinese output and activity has already turned the corner. The sooner that people stop calling the downturn and start realising that activity and sentiment is improving the better. Expect a very strong return post-Chinese New Year…there is no way that Chinese GDP growth will be below 8% in 2009.
brad – thanks for clarifying Dr Lardy’s position. It did seem a rather high amount.Guest – I hope you’re right, however given the outlook for the US and global economy it seems hard to believe that Chinese output has turned the corner especially as investment has continued to slow in Q4 and consumption is now slowing also. but we will watch and see in 2009.
says who? can you point to facts that activity and sentiment are improving? sources?
I read Brad Setser comment about your RGE views on China and he is wrong and you guys are right. By GDP numbers, if imports fell, the only reason why this happens is because internal demand fell, we have just to remember that imports just subtracts that part of internal demand that buys goods and services abroad:C+I+G = Cd+Cm+Id+Im+Gd+Gm, where d stands for domestic purchaces and m stands for imports.If imports are falling the reason to explain that is a falling internal demand. If internal demand is falling, the only reason can be the external sector weakness and the side-effects of this weakness on other GDP components.Michal Pettis wrote a wonderful piece about how a fixed exchange rate system will create bigger damages to the economies during crisis like the current one, by using historical examples, instead of using stupid econometric models.My end note is a question: “the economy can be bigger than the planet?” If the answer is no, the always forgotten variables (environment, planet, biodiversity, externalities, ecological services, etc.) will have to be considered, because the biggest crisis is to happen anytime soon: the planet systemic crisis. US and the advanced nations only developed without creating a planet collapse because they did this alone and because after they exhausted they own natural capital, they start to consume it from the rest of the world through global trade at a null cost, because like any market ruled by a blind price system, the environmental cost are ignored and socialized. So everyone at RGE has to start to have a more complete view of the economic system. It is false that economic system is neutral to the environment, like economists pretend, and is also false that the environment (through technological processes) is inexhaustible.Hugo Penteado
Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.
Hugo:I agree with your concern for the coming “planet systemic crisis”, and how trade short-circuits the natural (local) feedback loops which would call for solution to local problems, but in no way is the US a large deficit nation in terms of bio-capacity. In fact the other way around, few countries exceed its bio-capacity with Canada, Russia and Brazil well-placed. Where the US has been a debtor (of late) in the current system, it will be a sincere creditor when the system shifts, that too should by obvious and for any long-range planner should hold prominently in their evaluation of future worlds. In this system, US gets clothes and others get ports, roads, and electric grids.