Gauging China’s growth

Today’s commentary

China is a big wildcard for 2014. Growth slowed last year to a 14-year low. It isn’t yet clear if the trend will continue and what China’s leadership will do if growth does slow further.

Overnight a slew of China economic data was released. The most important figure was the 7.7% annual growth figure for 2013, which was the worst growth number in China since 1999. The media have made a big deal about this figure being a 14-year low. Nevertheless, the slowing was entirely expected. The question is what it means for China and those that trade with China.

The Chinese leadership had already pledged to move the economy away from export- and capital-investment-led growth. Doing so will require a huge rebalancing that will slow growth. And it has done. Investment accounts for almost half of Chinese economic output right now, and this was the largest drag on growth in Q4. The figure for Q4 was still 19.6% above year-ago levels according to ANZ Bank. But this is slower than the 19.9% growth pace ANZ calculates China racked up in the first 11 months of 2013. The push to restrict bubble-like credit conditions is having its impact. RBS thinks that the end of the year slowdown in China was acute because RBS estimates that industrial production, which ended 2013 at a year-on-year growth level of 9.7%, was 10.3% in October, meaning that November and December slowed markedly. This dovetails with the ANZ estimates.

The goal, of course, is to move to a more demand-led dynamic. And we do see consumer demand ploughing ahead, with retail sales up 13.6% in December 2013, the same as for year-on-year figures in November. But economists at Citibank believe higher interest rates will push down growth. My take here is slightly different because tightening into frothy markets can be an economic accelerator because it pulls forward credit demand. We could see this dynamic play out in the housing market in particular. China’s property market was a major locus of growth in 2013. Property sales rose 26.3% to 8.14 trillion yuan ($1.3 trillion), well ahead of 2012’s 10% rise in transactions volume. And note that the average selling price for new homes rose 9.2% in 2013. The largest cities also had the largest gains in price: Guangzhou at 20.1%, Shenzhen at 19.9%, Shanghai at 18.2%, and Beijing at 16%. Housing starts also rose in 2013, rising 13.5%, after falling 7.3% in 2012. So don’t count out another property-led boom in 2014.

As far as the rebalancing goes though, I have two positive data points. First, China’s 2013 oil demand rose at the slowest pact in at least 22 years according to IEA data. Demand was up only 1.6% to 9.78 million barrels per day. IEA had forecast 3.8% growth for 2013. Second, steel production in China is slowing. Apparently, the slowdown began in September and continued through the end of the year, with the biggest slowdown coming in November. And in December, the daily average production of steel fell to 2.01 million metric tons, the lowest level for the year. Both of these data points speak to the ratcheting down of the capital-investment led dynamic. President Xi Jinping is trying to get industry to  cut  capacityand overproduction as China produces about half of the world’s steel. On the other hand, Chinese electricity production grew 7.6% in 2013 to 5.2 trillion kilowatt hours, according to the National Bureau of Statistics. While this figure was inline with growth, it was higher than growth of 4.7% in 2012. Overall, I would say the picture is one of China attempting to move beyond the old growth model with varying degrees of success.

RBS expects growth in 2014 to rebound to 8.2%, not because of an economic accelerator but because the export-led growth dynamic will re-assert itself with the eurozone doing better than expected. Citibank and ANZ are forecasting further dips in growth, Citi down to 7.3% and ANZ down to 7.2%.

Where is this headed? What is clear to me is that the commodities secular bull market has been dealt a serious blow by what’s happening in China. I think that bull market is over. And that means trouble for the Australian economy, exports, labour market, house prices and banks. The Australian bull market is built on the commodities boom. And this has produced an epic bubble in housing. The wheels are going to come off this bubble and the 16% decline in the Australian dollar is not going to change this.

As far as China goes, debt stress has caused funding via the official sector to move to the shadow banks. Trust companies and other shadow sector financial institutions accounted for 30% of the 17.3 trillion yuan ($2.9 trillion) in credit last year, according to the People’s Bank of China. That’s up from 23% in 2012. So I am not at all convinced that we are witnessing a dramatic fall in Chinese growth. The tightening could in fact pull forward demand and increase growth as the housing bubble accelerates.

The big problem is the evergreening of bad debt in the state sector because local governments have established off-balance sheet entities to finance their capital investment-led growth and the crackdown on credit is a problem for these financing vehicles. The credit crunches we saw twice last year probably owed to issues emanating from that sector. Each time we saw a cash crunch though, the Chinese authorities were forced to relent and inject liquidity. So the credit situation is a delicate dance in China that in a Goldilocks scenario sees credit growth and economic growth slowing ever so slightly as it did in 2013. The risk is on both sides then – bubble-fuelled credit acceleration due to the tightening or credit collapse due to a lack of credit availability.

For China domestically, the path is still unclear though I tend to believe growth will continue to slow. The only obvious big loser then is Australia and other commodity producers like Brazil. The commodity boom years are over and this will have a negative impact on their economies.