China - Economy: How Worried Should We Be? – September 2012

British Embassy Beijing

Summary

Events in the Eurozone have hit exports hard, but domestic consumption has held up. On balance it looks as though stable growth will continue. Hence the authorities’ measured response to the slowdown, reinforcing property market controls and prioritising longer term reforms to put the economy on a more sustainable footing. They have plenty of room – and a wider range of levers to respond more aggressively if that should prove necessary.

Detail

China’s economy is underperforming, but is not yet seeing a hard landing

China’s latest GDP figure was the lowest in three years at 7.6 percent. Economic data has consistently underperformed expectations since April, and the July data was no exception. However, the slowdown is not impacting evenly across the economy.  Driven by events in the Eurozone, export growth has slowed dramatically. This has led to a particularly pronounced slowdown in the export dependent coastal regions.

However, even in China where 10 percent plus growth has become the norm, this is not yet a hard landing. If maintained, 7.6 percent growth is consistent with the Government’s 2012 growth target. And buried in the July data is a more positive story. Domestic demand has held up, and retail sales growth in July continued to strengthen. This is being driven by a steady increase in household incomes, indicative of a continued gradual rebalancing of the Chinese economy away from its exports dependence.

While recognising the challenges the economy faces, the authorities appear to remain relatively confident overall.  In a recent trip to Zhejiang and Guangdong, Wen Jiabao stressed that, in general, the direction of China’s economic growth remained unchanged. He emphasised that there were positive factors to stabilise growth, but made clear that the difficulties being experienced by the export sector needed to be taken seriously.

Less stimulus, more reform

So the response to the slowdown has been measured.   There has been some talk of stimulus measures, mostly from local Government.  However UK press reports of an 8 trillion RMB stimulus are exaggerated.

Central government is placing emphasis on the quality of growth rather than large scale stimulus. Their incentives are different to those for local Governments who still seek very high levels of growth. This has played out in housing, where a recent rebound in property sales and prices in some cities generated a central Government warning to local Governments not to relax property market controls.

The leadership has been focussing on longer term financial sector reforms to put the economy on a more sustainable footing.

On the employment side the outlook seems relatively benign. In 2008, at least 20m migrant workers lost their jobs and returned to their rural homes, triggering a massive stimulus response. Comprehensive labour market data is not available. But anecdotal evidence suggests the impact of the slowdown on employment this time round has been limited, with reports of job cuts by struggling coastal enterprises counterbalanced by reports of increasing labour demand inland. Only this week reports of a 16 percent increase in wages at Foxconn’s China plants hit the news.

There is evidently a risk that the economy will deteriorate further. Labour markets are a lagging indicator, and the firm level data is more worrying, with signs of falling profitability and low share prices.  However, if significant short term risks to the economy were emerging, it seems likely that the Government could pull levers with more direct effect.  For example, while Government controls on the property market are not the only factor in play, relaxing these would provide a significant lift to the economy. Monetary policy could be loosened further, and there is scope for further fiscal stimulus. Like in 2008, the banks could be compelled to increase lending. But most commentators believe a large stimulus package remains unlikely in the short term.

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