The economic outlook for China points to a bumpy deceleration that will last for a prolonged period with a large debt overhang, over-capacity and a generally weak external environment, likely to weigh on growth prospects in the years ahead.
That’s the view of Goldman Sachs’ chief Asia-Pacific economist Andrew Tilton who, in a research note released late last week, attempted to explain what is actually going on within the Chinese economy.
While Tilton admits that he has a “fair amount of confidence in the official data in terms of registering the broad pace of growth over the last 5, 10, 20 years”, he suggests that at present the economy is likely growing “a bit below 6%”, citing Goldman’s China activity indicator gauge, shown in the chart below.
The figure, while not far off, is below the 7% annual growth rate reported by the Chinese government when they released Q2 GDP figures earlier in the year.
“Alternative measures of growth suggest that the amplitude of the business cycle is bigger”, said Tilton, adding “at times like now when growth is weak, these alternative measures suggest something weaker”.
He also attempts to dissect why concerns over the outlook for Chinese economic growth have rattled markets in recent months. In his opinion, the rapid deceleration in growth witnessed in July and August saw concerns jump as the deceleration occurred at a time when monetary and fiscal policy already seemed to be reasonably supportive.
He also suggests that uncertainty surrounding economic policy in China is also contributing to amplification in market volatility, outlining three key areas of concern that are creating negative headwinds for sentiment at present: how aggressively policymakers will respond to economic weakness, the mode of policy that will be used by the government to help stimulate growth and whether policy will be as effective as it has been in the past given the current very high debt load, lower interest rates and some policy implementation problems that international markets witnessed, first hand, earlier in the year.
Tilton believes that while policymakers were clear in their strategy to boost growth earlier in the year, the response to recent economic weakness has been less clear, contributing to volatility in financial markets rarely seen in recent years.
“The new administration has tried to temper its support because many officials believe that the 2009 stimulus was excessive and contributed to the credit buildup and problems the economy faces today. In response to weakness in 1Q 15, authorities rolled out fiscal measures, cut short-term interest rates, and loosened housing measures. But the response to the more recent dip in activity has been less clear,” he said.
He suggests the recent one-off depreciation in the Chinese renminbi has been one of the chief reasons behind the increase in policy certainty.
“Historically, the response has been primarily via fiscal and money and credit expansion, i.e., domestic stimulus that would have positive spillovers to other economies. But the recent move in the renminbi (RMB) raised questions about whether more of the response might come via currency depreciation.”
Although the markets remain unconvinced, Tilton believes fears that policy stimulus will be less effective on this occasion than what has previously been seen in the past are “somewhat overdone”.
“We don’t think that the response will be primarily via the currency, which we think policymakers prefer to keep relatively stable in the near term. And while policies may not have quite as much impact as in the past, we believe they can still be efficacious for now,” he said.
On the outlook for policy stimulus, Tilton believes further easing would be appropriate at this point, but admits it would carry its own challenges given the nation’s large debt overhang, something that requires interest rates to remain at very low levels, along with the additional pressure on the renminbi that additional rate cuts would bring.
As the chart below shows, capital outflows from China hit a record high in August.
Although he believes the deceleration in Chinese growth will be bumpy and prolonged, Tilton suggests the slowdown will moderate in the months ahead as current drags on growth fade and additional fiscal stimulus is implemented.
“Shutdowns in factory activity — like the ones around the major military parade held in early September — have probably had a noticeable impact on national manufacturing activity. The explosion at Tianjin, which is one of the top ports in the country, might have also led to short-term disruptions in activity,” he said.
He also expects that an acceleration in fiscal spending, something that was evident in August when the government reported an annual increase in expenditure of 25.9%, will also contribute to a stabilization in growth in the latter parts of the year.
“We expect to see the impacts of policy support in the fourth quarter, particularly in the form of fiscal stimulus, as policymakers are now clearly encouraging local governments to spend more and accelerate projects,” Tilton said.
“This message was a bit muddied by efforts earlier this year to curtail off-balance sheet financing by local governments, but it’s getting across now, and we would expect to see some results in the near term.”
Chinese September quarter GDP is scheduled for release on October 19.
