Earlier this month the Wall Street Journal carried an article headlined “China’s holes in the road”. The journal contented that a recent slump in excavator sales is a lead indicator of a hard landing in China’s GDP growth.
The headline figures are indeed stark. Year-on-year excavator sales in May were down 9.6%. What’s more, sales of heavy duty trucks declined 22.4% over the same period.
The WSJ’s conclusions are simply sloppy! These data points do not necessarily indicate (and should not cause!) a sudden and quick slowdown in GDP growth and fixed asset investment. Why?
• Sales in durable goods are naturally choppy, and a contraction in excavator sales in May comes off the back of a massive 20.8% growth in April. Heavy duty truck sales did decline in April too (-8.3%), but this also comes off the back of a strong March (10.2% growth).
• A limited period of falling sales in such goods will not have a significant impact on FAI growth, as the actual number of outstanding machines continues to grow. In addition, industry can increase utilization rates, and increase the lifespan of outstanding machinery.
• The Chinese authorities have been implementing a process of tightening. This leads corporates to allocate more of their cash to more immediate concerns like working capital.
• As for a reduction in excavator / heavy duty trucks causing a slowdown itself…well it only accounts for ~1.7% of China’s fixed asset investment, and a third of excavators are actually imported!
Looking at the economy from another angle – what is there supporting a soft landing?:
• Money supply is still supportive
• Social housing should fill the gap left by private real estate developers
• Healthy overall fiscal situation
Yesterday Chinese Premier Wen Jiabao went online to answer questions posed to him by the public.
He stressed a number of themes in his answers:
- Firstly, and perhaps of concern for some readers, he set China’s growth projection for the period of its 12th 5-year plan (2011-2015) at 7%. We will come back to this point shortly.
- Interesting for the current climate in the Middle-East, he stressed that he understands that the combination of inflation and corruption leads to social unrest. He specifically mentioned that institutional reform is the long-term answer, and acknowledged that the cause of much unrest is the concentration and unchecked nature of power. Interesting.
- The Premier stressed that the stabilization of consumer prices were top on his list of priorities. He also mentioned that he expects household income growth to equal GDP growth, and wage growth to match labor productivity. In addition, he mentioned plans to raise wages for low earners, limit the top end of wages, protect legal incomes, and curb illegal incomes.
- He promised to bring the property market under control. One thing he stressed was the supply side of the problem. The Government plans to build 36 million social housing units over the coming 5 years, of which 10 million will be started in 2011 alone. I’ve written about my skepticism of the curbing real estate in previous blog entries.
- Personal income tax thresholds are to increase.
- Premier Wen said he will enact currency exchange reform, and plans to move towards a more flexible managed floating rate against a basket of currencies.
So he appeared to say the right things. His message was balanced and socially aware. But what about this 7% projection? Are we to believe that the heyday growth is behind us?! Is this a sign of impending tightening measures? The short answer is no, and here’s why:
- Firstly, the projection associated with the previous 5-year plan was… take a guess…7.5%! Over the previous 5 years growth was actually 11.1%. So the downward revision of 0.5% is actually small, and should be put in context.
- Secondly, this is a projection, not a target, which makes it non-binding. Beijing does not make targets!
- Beijing historically sets low projections to avoid disappointment.
- Beijing often sets low projections as a minimum to reduce both excessive competition on the local level, and to minimize data manipulation.
- In addition, we should not be shocked by this. Although 7% had never been announced as an official projection, the figure had been previously leaked in conjunction with the 12th 5-year plan.
Obviously the authorities are aware that the potential growth rate will gradually decline. Not only is the base for comparison getting tougher, but there are labor, resource and environment constraints too. So while I do believe growth over the coming 5 years will be above 7%, I have no doubt it will be below 11.1%. Perhaps 8.5% to 9.5% is a more reasonable expectation.
Growth spurred by lending
Last week economists were busy increasing their 2009e China GDP forecasts to around the magic 8% figure. The hike in new credit during 1H09 was surely a major contributing factor. During the first half of the year Chinese banks lent a record Y7.37bn, 300% larger than 1H08, and 47% higher than the government’s full-year 2009 Y5bn target.
Walking the tight-rope
The government is walking a tight rope, and will have to manage the economy to prevent assets bubbles, bad loans, and inflation, whilst simultaneously accounting for potential deflation (currently a concern in the US), and damaging shocks to the flow of capital.
President Hu Jintao told the Politburo on Thursday that the recovery was still nascent, and as such China would maintain its “relatively loose” monetary policy and proactive fiscal policy. On Saturday the People’s Bank of China (PBOC) said it “would guide loans to grow appropriately” and “will aim at better allocation of credit in the real economy.
Mopping up liquidity: Y100bn of notes announced
The PBOC has announced the issue of Y100bn of one-year bills to prevent a surge in lending in 3Q (note: July is historically China’s slowest month for new loans). According to Caijing magazine the PBOC has ordered the Bank of China (the county’s third largest lender) to purchase Y45bn of the notes, after the bank lent more than any of its competitors during 1H09. The notes carry 1.5% interest rate (lower than the general 2.25 deposit rate).
Expectation: measured approach – reserve rates to rise
I expect the government and its organs to continue taking a measured and pinpointed approach to ensure growth and suppress bubbles. As well as the new notes, I see banks reserve rates increasing from their current 15.5% for larger lenders, and 13.5% for smaller banks. I see an increase in reserve rates most likely to wait until 2010, unless data for credit extended in July and the coming months exhibits any significant spikes.