China’s flailing economy journeys into the unknown

China Air Pollution
Michael Sainsbury

China’s economy is moving closer to a possible dramatic tipping point as growth continues to slow and overall domestic confidence appears to be sapping.

Official figures released today reckon that the economy grew 7.4 per cent on a yearly basis, the slowest pace since 2012 and down from 7.7% last quarter but this disguises the fact that quarter to quarter growth slowed to a crawl at 1.4 % down from a sluggish 1.7% last quarter.

How anyone in the markets can see this as good news is bewildering.

It was unsurprising the often highly massaged GDP numbers came in just 0.1% ahead of market consensus, it’s a regular gift to the markets from China’s National Bureau of Statistics as the Chinese government does not wasn’t to spook all the horses in the stable at once.

But most of the key trends are pointing one way, and it is not up.

GDP may have been nominally just a tad ahead of expectations but March data was pretty much worse than expected across the board. As well as continuing tighter credit growth in investment continues to ease offand falling housing sales “all point to further downward pressures”, HSBC said.

So the real question is that while it remains unclear by how much growth is slowing, what happens next?

Already Chinese Premier Li Keqiang had said in three separate public speeches, the most recent at the Boao Forum for Asia two weeks ago, that the central government would instigate polices to yet and make sure the economy hooves reasonably closely to its growth target of about 7.5%.

The initiatives, so far, have been to accelerate public housing and subway construction, a series of tax breaks for SMEs although still no signs of giving them access to the credit they need.

Li, again, so far, has made it equally clear that there will not be concerted stimulus, but both he and his predecessor Wen Jiabao have said this before and then recanted in the face of slowing growth. The government’s 7.5% is widely a “soft” target with most analyst tipping annual growth somewhere between 7% and 7.5%.

ANZ for instance is predicting 7.2%, Nomura 71.1% and so on – but let’s not get too hung up on the numbers because nothing in that range remotely resembles the nightmare scenario of sharp slowdown. There are growing concerns this is now more possible than it has been previously, largely due to the rapid ramping up of debt over the past 5 years.

Here are a few reasons why people should be more worried than they were last year about the Chinese economy.

The most interesting part of the China story right now is tightening credit. New credit for the first quarter fell a whopping 19% compared with last year and money supply, or M2 as it is known by economists, grew at its slowest pace since 2001.

This will take a few months to feed into the economy but its singular effect will be to slow growth further if the trend continues.

Another interesting and concerning data point was that the slowdown was mainly led by secondary industry sectors (7.3% y-o-y vs. 7.8% in 4Q) while tertiary industry growth also moderated to 7.8% (vs. 8.1% in 4Q 2013) which somewhat belies the services sector boom being a new economic driver touted in some quarters. Right now the across the board gloom seems to be about a general lack of confidence and that can start feeding upon itself

As credit tightens China looks set to feel some Western style “market forces” with a long period of company defaults on both bond payments and “entrusted loans – generally made by big usually state owned companies with access to cheaper capital as the corporate sector begins the painful process of deleveraging.

At the core of all this is the Chinese property bubble, housing stocks in many second third and fourth tier cities runs past five years in many cases, the so-called ghost cities and suburbs strewn across the land.

The recent 30% slump in property prices in the major centre of Hangzhou, capital of wealthy Zhejiang province, and at the very top of the second tier is of particular concern. If this is a taste of things to come in other similarly sized (about 8 million people) cities then look out below.

Sales volumes in March were roughly 35% down year on year, and preliminary data from April suggested that sales volumes continued falling by more than 20%. Demand for steel and cement is abnormally low for the spring season, and inventories are rising,’ Anne Stevenson-Yang of J Capital Research said in the company’s weekly client note.

Stevenson –Yang is notoriously bearish but her time may be coming. If, indeed the Chinese property boom is seeing an end she mused that all assumptions about urbanisation rates may have to be thrown out the window, causing chaos to, amongst other things, Australia’s economy

Still, at present there is general confidence that China’s slowdown can be managed gradually, step-by-step but risks are increasing so at some point – and the timing inevitably takes most by surprise – it may trigger that feared sharp decline. If things start looking too bad come May, the government could well decide to step up its easing efforts but will be concerned that it is just exacerbating existing problems and putting off the inevitable.

Still, while economists maybe be worried the ever-confident executives at Fortescue Metals are not. In the companies monthly conference call yesterday chief executive Nev Power was effusive in his confidence that China would continue to grow in much the same way it has in the past couple of years at about 7.5%.

Fortescue and BHP are both shipping more iron ore than ever according to their quarterly production reports issued today. Yet property in China the main consumer of steel is on a significant downturn and there have been increasing reports of credit being turned off for small mills and traders, There is now little doubt that China’s mega boom years are over but the immediate future could go several ways. Power and his shareholders may be in for nasty shock.