China: Disappointing growth not necessarily bad
Economic Quarterly Report
Contrary to earlier expectations, China’s economic growth slowed slightly.
This was not necessarily bad news, as the growth rate remained between 7.5%-8%, whereas significantly stronger or weaker growth would currently both be undesirable.
In the first quarter of this year, economic growth in China slowed to 7.7% year-on-year (figure 1). The growth acceleration witnessed in the last quarter of 2012 had been expected to continue.
Figure 1: First-quarter growth disappointing
The figures posted for January and February were neither clearly positive nor negative, but in March it became evident that the economy was slowing again. The clearest marker was that growth of industrial production slowed to 8.9% year-on-year in March from some 10% in the preceding months. On the demand side, a less upbeat sentiment among consumers curtailed spending; retail sales growth, for instance, was flatter at 12.4% y-o-y than in 2012. Growth of investments was likewise weak, in Chinese terms, at 20.9% in the first quarter compared to a year earlier. Investments were moreover targeted mainly at infrastructure and real estate and to a significantly lesser extent at the manufacturing industry, which is faced with surplus capacity.
Consumption (4.3 percentage points) consequently made a larger contribution to first-quarter growth than investment (2.3 percentage points), a reversal of the usual pattern. The remaining 1.1 percentage points were provided by the external sector. A major caveat is in order here, however; the export figures for January and February, when export growth amounted to between 20 and 25 percent compared to a year earlier, principally as a result of an enormous increase of exports to Hong Kong, appear to be inflated. To sidestep restrictions on capital inflows, these are disguised as exports. In addition, inflating their exports also enables exporters to claim higher VAT refunds from the government. After the government tightened its checks and controls, export growth flattened to 10% y-o-y in March. This also means that actual first-quarter GDP growth is in fact likely to have been slightly lower still than the official figure.
In its official statements, the Chinese government does not appear to be concerned about China’s lower than expected economic growth in the first quarter. It refers to developments as stable and does not intend to roll out further economic stimulus. But the reality is more complex.
Figure 2: Alternative forms of credit popular
Very strong credit growth over the past few years has led to an enormous increase in the total volume of credit in the Chinese economy. In addition to bank loans, other forms of credit have also increased significantly in the past few years (figure 2). These include ‘trust loans’, for instance; short-term loans provided through trust companies to companies with comparatively high risk profiles. Increasingly, banks have also stepped up their use of off-balance sheet capital products. This enables banks to create a degree of flexibility within the tight Chinese banking regulations. This makes it difficult to gauge exactly how much credit is in circulation, but most estimates assume a percentage of 200% of GDP, or more. For the time being, this does not necessarily have to be a problem. Interest rates in China are still low, and the debt is still manageable as a result. It does however increase the economy’s dependence on the banking sector, and hence its vulnerability to problems in that sector. This restricts the government’s policy options, as the consequences for the banking sector need to be taken into account as well. Excessively sluggish growth would for instance adversely impact operating profits and tax revenues, which would make it harder for companies and government authorities to repay loans and would consequently push up the volume of bad loans at banks. The government’s options for stimulating the economy have become more restricted as well, because this is usually largely financed by banks, with the attendant risks for the banking sector. In addition this would, as already happened in the past, drive up real estate prices further, which is something the government is specifically aiming to avoid. Fast-track growth is likewise undesirable. It could cause inflation to rise, necessitating monetary tightening. Increasing interest rates involves risks however, as it would make many debts untenable.
In sum, the government would be satisfied to see GDP growth of between 7.5 and 8 percent this year. Slower growth could lead to rising unemployment and increase the risk of social unrest. In that case, the government is likely to accept the risks for the banking sector and nonetheless stimulate the economy (to the minimum extent necessary). This is a distinct possibility, as the figures for April do not indicate any real improvement yet and the contribution of the external sector to GDP growth will also be lower in the second quarter. At the same time, there is hope that the surge in lending of the past few months will lead to acelerated growth in the coming quarter.
This is a translation of a part of the Dutch version of the Economic Quarterly