Shocking figures

In the never-ending game of trying to determine the state of China’s economy, broad measurements like GDP growth have tended to attract coverage disproportionate to their accuracy. It is less publicized statistics such as electricity output that may offer a clearer – and altogether more pessimistic – outlook.

"Things like GDP and industrial production can be very easily massaged and you never know what’s in them," said Jim Walker, an economist with Asianomics, an independent research house in Hong Kong. "At least with electricity production, it’s pretty straightforward. It’s the number of kilowatt-hours that they produce."

And China has been producing fewer kilowatt-hours (kWh). In January, total electricity production – roughly equal to total power consumption – fell for the fourth consecutive month, to 247.6 billion kWh, a 12.8% drop from the year before. Demand was up 4% year-on-year in February, but analysts caution that last year’s Lunar New Year in February may have depressed its figures.

Nevertheless, the structure of China’s economy means power numbers can be taken as a reasonably accurate measurement of industrial activity on a month-to-month basis. Fran?ois Nguyen, senior policy advisor for electricity markets at the International Energy Agency (IEA), said that approximately 70% of China’s power demand is tied to industry. The steel and cement industries, closely linked to a range of sectors including property, manufacturing and infrastructure, account for 25% of demand.

Any kind of power consumption increase – such as February’s – may therefore sound encouraging. However, chronic oversupply means the news is more likely bad than good. Rampant construction both in China and internationally long masked overcapacity in major sectors like steel, but the downturn has laid it bare. Exacerbating the problem, many producers aren’t slowing down.

False recovery

"In China you’re looking at … as much as 200 million tons a year of excess capacity [of crude steel production]," said Graeme Train, an analyst with Steel Business Briefing in Shanghai. "China’s total steel production capacity is about 650-660 million tons a year. So basically a third of it is not going to be needed this year."

Making matters more difficult is the nature of an apparent recovery in demand for steel. After a period of destocking in the second half of 2008, manufacturers and construction firms began buying again, but not in large quantities. Speculative purchasing by traders then helping to push demand up, leading to a 2.4% year-on-year rise in crude steel output in January and February. This was largely responsible for the 15% increase in steel prices between December and February.

"Producers all jumped on what looked like a demand recovery, when actually it wasn’t," said Train.

As the nature of the steel demand became clear, prices fell 6.8% in a week at the end of February.

Viewed in this context, the rising power demand figures appear to betray vulnerability in the market rather than strength. The risk of misinterpretation is heightened by the fact that power figures leave out large sectors of the economy.

"It’s only a proxy of industrial production … It does not give you a good sense of how the agriculture sector is doing, how the service sector’s doing," said Tao Dong, an economist with Credit Suisse.

But while it may not give a complete picture, the speed with which China’s power demand growth has trailed off is troubling. Taken either way, the numbers are bad: A rapid fall may mean painful contraction, but an even more serious risk could be posed by too much production.

Walker of Asianomics points to the rise in money supply and loan growth figures as an area of particular concern. Continued increases would lead him to raise his GDP growth forecast  for the year – 0-4%, with a 30% chance of contraction – but he says it would make him less positive about investing in China.

"What you’re doing is expanding capacity into overcapacity, which makes no profit sense whatsoever. It eventually leads to a much worse downturn," said Walker.