RaboResearch - Economic Research

Country Report China

Country Report


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China’s housing market has been weakening recently, but exports seem to do rather well. The latest PMIs suggest the country should be able to avoid a hard landing.


Strengths (+) and weaknesses (-)

(+) Sizeable growth potential

China’s GDP per capita is still relatively low and the country has so far managed move gradually up on the technological ladder. As a result, GDP growth is likely to remain strong, although we expect grow to decline gradually and policy reforms will be needed to sustain growth in the longer term.

(+) Exceptionally strong external (liquidity) position

China’s vast amount of FX reserves, amounting to USD 3,950bn at the end of the first quarter of 2014, and low external debt give it an exceptionally strong external creditor position. External liquidity risk is very low.

(-) Growth model is unsustainable

China has to change its growth model and increase market forces in its economy to reduce inefficiencies and ensure sustainable growth in the future. However, China has so far lagged in the implementation of many vital reforms to make growth sustainable.

(-) Weak accountability of the government

High levels of corruption, weak protection of human rights, strong influence of the Chinese Communist Party on the judiciary and lack of democracy implies that the Chinese population cannot hold the government accountable for its actions, which increases the risk of public unrest.

Key developments

1. Housing market has been weakening

Fears of housing market weakness have taken the headlines again recently. The government still seems to have some means to avoid a total collapse of the housing market, but a necessary slowdown in building will nonetheless lower economic growth. In the past decade, the Chinese housing stock has increased extremely rapidly. Almost every year the number of house completions has increased and the increase in the building volume is estimated to have contributed about 1%-point to growth in 2013. As the building volume has grown rapidly, while the pace of urbanisation is expected to slow gradually, fears of oversupply have been growing. Recent data show that the housing market has already been weakening. In a growing number of cities, housing prices are flat or falling according to official data and in the first months of the year, house sales fell by 8.6% y-o-y. Especially in some provincial cities, the stock of unsold houses has grown rapidly. The government is still in the position to limit the weakening of the housing market with some stimulus, and  has to some extent already done so. Furthermore, China’s financial system remains under strict government control. As a result, the risk that bankruptcies in the property sector would lead to a freeze of the credit system is small. However, even if there will be a soft landing of the housing market, it seems very unlikely that house building can boost growth as much as it has done in recent years (it is estimated that house construction accounted for almost 10% of GDP in 2013). The number of housing starts already fell strongly in early 2014. This poses risk for local governments, as land and house sales account for a sizeable share of their income.

2. Exchange rate depreciation

A remarkable development on the external front has been the depreciation of the exchange rate since the beginning of this year. After a nearly uninterrupted appreciation against the US dollar, the Chinese currency started to depreciate in the middle of February. As the central bank continued to increase its stock of foreign exchange reserves, the depreciation was the result of government policy. It seems the government was intent on discouraging speculation on continued appreciation of the yuan, as these speculative inflows tend to boost credit growth and lead to further upward pressure on the exchange rate, even as the current account surplus has fallen strongly in recent years. Trade data at first sight seem to suggest that the latter trend continued, as nominal exports fell by 18.1% y-o-y in February and 6.6% y-o-y in March. As the nominal imports still grew rapidly, China posted a trade deficit in February. In March, the trade account turned into surplus again, partially thanks to a strong decline of imports in March. However, exports have done less bad than the official data suggest. First, the data were distorted by the Chinese New Year. Second, there was a strong over-reporting of exports to Hong Kong in early 2013 due to over-invoicing of exports, as parties were speculating on a further appreciation of the yuan. As these types of hidden capital inflows fell strongly due to the sudden depreciation of the currency, according to the official data exports seemed weaker early this year than they in fact were. Meanwhile, exports seem to be gaining momentum, as the new export order component of the HSBC/Markit manufacturing PMI for May was very strong, and nominal export growth increased to 7% y-o-y in May. 

Figure 1: Exchange rate
Figure 1: Exchange rateSource: Ecowin
Figure 2: Manufacturing PMIs
Figure 2: Manufacturing PMIsSource: Ecowin, HSBC/Markit

3. Growth falls to 7.4%, but effects of growth slowdown seem manageable

In the first quarter of 2014, economic growth fell to 7.4% y-o-y, the slowest pace in 18 months. So far, the impact of this most recent growth slowdown seems to be manageable. The labour market remains tight, as the number of vacancies per job seeker is still very high, while migrant wages seem to continue to increase rapidly. The tightness of the labour market makes it easier for the government to accept a moderate slowdown, as it reduces the risk of social unrest. Second, the economic tide seems to be turning. According to the HSBC/Markit and official manufacturing PMIs, economic sentiment improved in May. It seems that the mini-stimulus measures the government announced earlier this year, such as additional investments in housing for low income households and the frontloading of infrastructure investment, and increasing foreign demand as western economies are recovering gradually, are putting an end to the slowdown. A hard landing seems therefore unlikely at this moment. Nevertheless, economic growth is likely to fall gradually in the coming years, as the Party will try to reform the economy gradually and economic growth will be less driven by credit and investment growth, and housing construction. While the government has taken some steps in the reform process in recent months, such as allowing the first corporate default to take place in China and giving local governments the green light to issue bonds, it also announced new small stimulus measures in May, such as a lowering of reserve requirements for some loans. Although the measures announced so far have a targeted instead of an across the board nature, there is a risk that stimulus may once again fuel credit growth and thus slow the structural transition that China has to undergo to avoid bigger problems in the future. 

Factsheet of China
Factsheet of ChinaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

China is the second-largest economy in the World - after the US - measured in both nominal GDP (USD 9,324bn in 2013) and in PPP terms (USD 13,572bn in 2013, the International Comparison Program has recently made an important upward revision of China’s GDP in PPP term, but it has not yet published a 2013 figure). At the heart of China’s economic success has been its successful export- and investment-led growth model. However, in recent years, growth has been increasingly driven by credit and (real estate and infrastructure) investment growth. Meanwhile, adverse side effects, such as a rapid rise in income inequality and major environmental problems have become too big to ignore. China’s growth model will have to be changed and become more consumption-driven instead of investment-driven. Innovation will have to be nurtured, while environmental responsibility will have to gain in importance. The 12th 5-year plan, launched in March 2011, and the late-2013 Third Plenum address these issues, but implementing the plans correctly and timely will be a key challenge for Chinese authorities while major downside risks, such as a sharp economic slowdown or public unrest are present. The People’s Republic of China, established in 1949, is a socialist one-party state ruled by the Chinese Communist Party (CCP). Power is centralized in the CCP and the support of the People’s Liberation Army and a well-developed internal security system safeguards political stability. The availability of information is heavily controlled by the government. Press freedom and freedom of speech are heavily restricted, while the judiciary is not independent. As a result, developments in China, especially political ones, remain clouded and difficult to gauge due to lack of transparency.

Economic indicators of China
Economic indicators of ChinaSource: EIU, Rabobank

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