It is still too early to argue that China’s economy is on a sustainable rebound, but the tentative evidence is there. It strengthens the case that GDP growth will accelerate in the second half of 2009 to reach about 8% for the year.
The headline purchasing managers’ index (PMI) in December recorded its first increase since peaking last April and this momentum was carried over into January. The PMI, which provides an overall view of manufacturing activity, hit 42.2 for the month, up 1 point from December.
Admittedly, 42.2 is far from a strong figure – a reading below 50 indicates the manufacturing economy is generally declining – but two consecutive month-on-month increases suggest stabilization. The PMI new orders index also rose for the second consecutive month.
More positive signs were found in power generation, which in December posted its first month-on-month increase since July.
Some of the rise in power generation was due to the first month-on-month increase in steel output since last June. This came as small mills took advantage of relatively cheap iron ore prices to begin ramping up production of long product, in anticipation of renewed demand in the coming months thanks to the government’s infrastructure stimulus program.
Much of the data is still, on a relative basis, quite weak. And given how far down most indicators have fallen from sky-high peaks, it will probably be well into the second half of 2009 before we see any year-on-year growth. Indeed, some of these indicators may even retrace their steps a bit in the interim.
Come March or April, the surge in infrastructure-related demand already anticipated by the steel industry is likely to have crystallized into new orders for cement as well as steel, at a time when inventories should be relatively low. In both cases, there should be a return to steady month-on-month increases in production. This will have a knock-on effect on the power generation figures, since cement and metals account for about 25% of power consumption.
A sustained turnaround in home sales, with volumes rising on a month-by-month basis, is expected by the middle of the year. However, this will depend on a strengthening of consumer confidence, and this is the aspect of the Chinese economy for which we have the least visibility.
As the economy has slowed, Chinese consumers have retrenched – but only slightly. Nominal retail sales growth peaked at 23.3% year-on-year in July, but it was still 19% in December. In real terms, sales rose 17.4% in December, up from 15.4% in July.
There are several reasons why the Chinese consumer isn’t going to follow his American counterpart off the cliff: American shoppers capitulated as soon as their economy went into recession, while Chinese continued to shop aggressively through six consecutive quarters of slowing GDP growth; urban and rural Chinese have seen real income growth of at least 8% for eight years and five years respectively; and Chinese households have almost no debt, almost no mortgages under water, and can count on banks that are willing to lend to them.
Consumption is likely to continue to slow slightly – in nominal terms – in the first half of 2009 before strengthening in the second half. When key indicators register sustainable month-on-month increases in the second quarter, Chinese consumers will regain their confidence in the economy.
One of the reasons China’s economy slowed last year was the government’s decision to tighten credit flows to several sectors. In November, Beijing announced that those controls had been lifted, and that banks had been asked to boost loan growth.
December data showed that this process was well under way – new lending rose by over 1,000% year-on-year.
In 2007, Beijing worried that too much money was being spent on real estate and local infrastructure projects. It moved to cool off these sectors, primarily by limiting lending to property developers and to local government projects. Steps were also taken to discourage consumers from buying apartments.
The sharp reduction in credit flows to developers was responsible for a sharp reduction in new construction, which in turn led to a steep rise in steel inventories. Meanwhile, the combination of anti-property policy measures and credit cuts held down new home sales, prompting a fall in mortgage lending and property prices.
The economic slowdown deliberately created by Beijing soon ran head into the global recession, and in November the government realized that the credit controls needed to be lifted. Banks were instructed to resume lending to developers and local infrastructure projects, and a series of interest rate cuts and policy changes were designed to encourage people to buy apartments.
Some observers worried that Chinese banks would, like US banks, refuse to increase lending given the global economic uncertainty. But in China there is only a credit crunch when the political leadership wants one. Chinese banks are not only very liquid, they will lend when directed by the Party, which appoints all senior bankers.
Lending rose sharply in December, with growth in outstanding loans increasing 18.8% compared to 16% in November.
Much of this money is going toward Beijing’s infrastructure stimulus program, but small- and medium-sized enterprises (SMEs) in the private sector also appear to be benefiting. In a CLSA survey of SMEs, 49% of respondents said it was easier to borrow in the fourth quarter compared to the third quarter. When the same question was posed back in the third quarter of 2008, only 20% said borrowing had become easier.
In an additional step to promote lending, the government has freed small- and medium-sized banks from the constraint of maintaining a loan-to-deposit ratio of less than 75%. This will allow some of those banks, who have had trouble boosting their deposit base, to increase lending. Larger banks, which have huge deposit bases, have not been constrained by the 75% limit.
While this burst of new lending is positive for the overall economy, it is not good news for bank profitability. Credit costs will have to increase at a faster pace and that will push down earnings. Beijing is clearly asking banks to make sacrifices for the greater good of stronger macro growth.
China’s exports were down 17.5% year-on-year in January, and imports fell by 43.1%. While it is clear that exports and imports remain very weak, there is only so much that can be interpreted from this data, due to the holiday distortions. January 2009 had 24% fewer working days than January 2008, a substantial difference.
But it is worth stressing that, although exports are likely to remain weak, this does not doom the Chinese economy, which is primarily driven by domestic investment and consumption. Net exports are equal to only about 5% of total industrial output, so factories – and consequently GDP growth – will respond more readily to fluctuations in domestic demand than changes in the US economy.
To reiterate: The key to a much stronger second half will be whether the huge boost in credit, the stimulus program and the government efforts to re-start the housing market all gain traction by the second quarter.