China's Economic Growth Still Robust, But For How Long?

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The latest figures coming out of China suggest that the economy is recovering in the second half after experiencing a slow down in the first. This development dumbfounded many people, this writer included, who had expected a continuing decline, as the global economy recovered at a slow pace and Beijing tried to steer the country away from relying on its traditional export-led model and towards more internal consumption.

In September, China’s steel production rose 11% year on year. Meanwhile, coking coal imports jumped 19% month on month and 200% year on year on an annualized basis, according to Bloomberg. According to the FT, China’s economy expanded by 7.8% in the third quarter from a year earlier, speeding up from 7.5% growth in the second quarter as it benefitted from both better exports and solid domestic demand.

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Yet critics suggest the rebound in China’s economy was largely the result of government efforts to shore up growth with looser monetary policy and a “mini-stimulus” of investment in infrastructure such as rail and subway systems. In a separate article from last week, the FT reported that data released by China’s National Statistics Bureau showed that growth in industrial activity, retail sales, and fixed asset investment all slowed in September, in comparison with previous months. Industrial production in September increased 10.2% from a year ago, down from 10.4% expansion in August, while fixed asset investment and retail sales both decelerated slightly to grow by 20.2% and 13.3%, respectively.

Those may be phenomenal figures, but detractors would say that they point to an economy that’s still too reliant on fixed asset investment for growth, despite Beijing’s efforts. The growth rate of the Chinese economy has decelerated in 11 of the past 14 quarters, falling from an expansion rate of nearly 12% at the start of 2010. Economic growth in 2012 was merely 7.8%, the slowest pace in 13 years. And if the rate drops below 7.6% for 2013, it will be the economy’s worst performance since 1990, when the country faced international sanctions in the aftermath of the 1989 Tiananmen massacre. While overall inflation has remained under control, the housing market remains the largest driver of the Chinese economy.

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To put it in context, a recent Economist Intelligence Unit report quoted Robert Ward, the EIU’s China Market Director, on China’s large construction sector. It has the capacity to build a city the size of Rome every two weeks, making its impact on commodities and Chinese (and hence global) growth the single most important economic activity in the world. Yet, if property price increases do not moderate in China, Beijing may have to apply the brakes and choke off a key driver of the economy.

In spite of upbeat third quarter numbers, some think China is at a crossroads if it wants to address deep rooted structural issues that threaten sustainable growth and even social stability. Wang Tao, chief China economist at UBS, is quoted as saying, “If the new government does not launch sweeping reforms now, many people believe China’s economy is heading for ruin.”

Barclays economist Jian Chang, agrees: “Fundamentally, we believe the challenges facing the Chinese economy have not been addressed, namely industrial overcapacity, high corporate, and local government debt intertwined with risks associated with a rapidly growing shadow banking sector and a latent property bubble.” He goes on to cut the bank’s 2014 GDP growth forecast to 7.1% (from 7.4%) due to slower potential growth, significant financial and fiscal risks, and the urgent need for economic structural reforms.

Our expectation remains that the country faces overcapacity in many industries, and there are some deep structural issues that need addressing. The mini fiscal stimulus from early summer is providing a boost for now, but may prove, in hindsight, to have been more of a sugar rush.

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