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China: rotation underway, soft landing ahead


Harry Tan (Head of Research, Asia-Pacific) discusses the slowdown in China and whether it's too late to tap into the growing consumer story.

The economy is slowing…
It should come as little surprise that in the first quarter of this year, the Chinese economy grew 6.7% from a year ago, compared to 7.0% the quarter before and 6.9% for the whole of 2015. The slowdown is expected, reflecting both external and domestic headwinds. To be sure, global demand has been soft and uneven, exacerbated by the financial, currency and commodity markets’ volatility so far this year. While the US has continued to outperform, there are also recent signs of a slowing in real economic activity. That, in turn, has led the Fed to provide a more dovish outlook for future interest rate increases. Japan is also struggling somewhat, and the near-term outlook is overshadowed by the recent Kumamoto earthquake on top of tightening financial conditions (from the yen appreciation). The domestic growth outlook is further complicated by policy pressures to reduce the over reliance on investment-led expansion, which has widened the output gap, and driven down producer prices and industrial profit sequentially over the past 2-3 years.

…but downward momentum is stabilising
All said, the key messages from the latest GDP report are multi-fold:
1) A modest credit stimulus deployed since late last year has helped to stabilise growth at a level which policymakers are “comfortable” with.  The slowdown has also largely been priced in, which explains the markets’ rather muted reaction to the latest growth outcome (see Fig.1).
2) In this regard, another bout of expansive fiscal stimulus is unlikely. While the Chinese government was highly concerned about subdued data flow heading into 2016 and short-term growth significantly undershooting the full-year target of 6.7%, this fear — which will in turn negatively impact on investor sentiment and outlook for the RMB and capital flow — has now been allayed. A full-blown fiscal expansion programme will also complicate existing efforts to control total indebtedness at close to 300% of GDP. That said, selective fiscal and monetary stimulus should still be expected to normalise growth conditions as the restructuring efforts continue.
3) Therefore, while a hard landing is and should not be a central case scenario for China’s growth outlook, a reacceleration is also unlikely as policy direction is still focused on rebalancing the economy for healthier long-term trend growth.

Consumers holding the fort and rotation is underway
Therein lies the good news. Even as the modest credit stimulus and a housing market rebound catalysed the pick-up in investment and industrial activity in the first quarter — hence reducing anxiety about a hard-landing — the truly real and positive story lies in the consumption landscape. In the first quarter this year, real retail sales stayed robust, running at a relatively similar pace of 9.6% versus 10.7% a year ago. That, despite real urban income rising by a slower 5.8% last quarter, was about 17% lower compared to a year ago. Still strong consumer confidence over future earnings growth and a high level of savings likely underpinned consumer spending alongside rising services employment. This trend will continue, as urbanisation, hukou and one-child policy reforms are expected to create roughly 500 million middle-income households in the coming two decades. This rebalancing will persist: after bottoming out in 2010, private consumption as a share of the economy has been on an uptrend (see Fig.2). From another angle, the tertiary sector accounted for 57% of the economy in the first quarter, from slightly above 50% last year and 41% a decade ago. This is the fifth consecutive year in which the tertiary activities accounted for a bigger share of the economy compared to other industries.

Not too late to tap into the growing consumer story
China is changing and will continue to evolve. The economy has already made significant economic and social progress since market liberalisation in 1978 (see Fig.3). Previously, top-line growth has been driven by investment and capacity expansion in manufacturing. Now, even as the economy is slowing and concerns are persisting over trend growth, the middle class is picking up the growth slack. As China continues to transition into a consumption-led growth model, in line with the experiences of other Asian economies witnessed over the past three decades, the consumer story will get even bigger. This transition will be bumpy and carries risks of policy misalignments. But there is little doubt that more Chinese will move into cities and the quality of the labour force will continue to improve as nearly seven million graduates enter the expanding services sector at higher wages. A better quality workforce, improving productivity and moving higher up the industrial value chain will add up to further wealth creation and higher propensity to spend. We therefore continue to believe that the Chinese consumer growth story remains compelling. 

Source: National Bureau of Statistics of China, 2016

Fig. 2

Source: National Bureau of Statistics of China, 2016

Fig. 3

Source: World Bank, 2016


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Harry Tan

Harry Tan

Head of Research, Asia Pacific

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