September 18, 2020

China: Slowing but not crashing


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shanghaiBy Jens Erik Gould From The Financialist
If there had been any doubt, the third quarter seems to have proved what many investors have been fearing all year long: the Chinese economy is experiencing a structural slowdown. Data released this week showed year-on-year growth of 7.3 percent in the July-to-September period. On the one hand, it’s quite impressive; few countries boast growth levels anywhere near that. On the other, it’s a reversal; after unexpectedly accelerating in the previous quarter, during which it grew 7.5 percent, and third-quarter growth was the weakest in more than five years, a reflection of a sluggish real estate market and weakening domestic demand. It also increases the likelihood that the world’s second-largest economy will miss its annual growth target—set by the government at 7.5 percent—for the first time since 1998.
Two key parts of the economy—namely, exports and a property market that represents around one quarter of GDP—are simultaneously slowing after a decade of growth. Residential property sales are in complete reversal, and fell 10.8 percent in the first nine months of this year. Worse, there are no new sources of growth in the economy to compensate for the weakness. E-commerce is growing and renewable energy could spark the economy down the road, but neither is sizeable enough at present to act as a counterbalance. As a result, China’s economy will likely keep decelerating—fourth-quarter growth is forecast at 7.2 percent—and will continue on that path next year, according to Credit Suisse analysts Dong Tao and Weishen Deng. “The problems in the economy remain unsolved,” they write in an October 21 report.
The silver lining in it all: the main challenge for Chinese policymakers today is managing the adjustment to a new paradigm of lower growth, rather than preparing for a crisis. Economic growth has slowed gradually, rather than crashing, suggesting that the country might yet avoid a hard landing. Concerns at the start of the year that trusts and wealth management funds could default have fallen away, as there appear to be no looming issues that threaten to destabilize the financial system.
One confidence booster: the government has both the motivation—and the means—to arrest any steeper decline that might materialize with a substantial stimulus package. It has room, for example, to cut either its reserve requirement ratio or real interest rate. The central government could also take on large amounts of debt if necessary, which would make up for the more limited borrowing capability of local governments. Credit Suisse actually expects the central bank to cut the reserve requirement ratio or increase the loan deposit ratio in the fourth quarter, which could help make up for more tepid investment by local governments and bank lending.
A handful of short-term indicators are also blinking positive. Exports rose a better-than-expected 15.3 percent in September from a year earlier, while imports rose 7 percent, suggesting China is both benefitting from a strengthening U.S. economy and experiencing domestic demand that’s not as weak as anticipated. Industrial production rose a better-than-expected 8 percent in September, as auto production and computer manufacturing improved from August. All the while, the government continues to implement economic reform measures aimed at boosting private investment, government revenue and productivity. Credit Suisse expects the government to start more rail and subway projects in the fourth quarter, which would mean increased investment and more jobs.
The bottom line? Chinese equities may not be as unattractive as the bears might think. Indeed, the bulls have been in charge of late, as the Shanghai Composite Index rose 16 percent between July 21 and October 8, and hit an 18-month high earlier this month amid optimism about the government’s reforms. There also remain a few straight-up growth stories in the equity market, including “new economy” stocks in healthcare, Internet and some consumer sectors. Still, it’s important to be realistic. China was never going to be able to maintain the breakneck growth trajectory that had already lasted longer than expected. And the transition is now. “China’s growth,” Tao and Deng point out, “is moving to a new norm.”
Photo of Shanghai skyline courtesy of Songquan Deng /

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