China’s publication of Q3 (third quarter) retail sales, industrial output and fixed investment all ended above expectation. GDP, at +4.9% YoY Q3 - 2023, within a whisker of the vaunted 5% goal, beat expectations (4.5%) comfortably
Timing of the favorable GDP data may have been convenient (just before the third Belt and Road initiative Forum in Beijing) or just coincidental
Markets – so it seemed – accepted the news with relief, proving once again that good news will be, as a matter of course, taken at face value
However, economic growth records (in real terms) must be measured reliably over time and the outlook has to be in line with macroeconomic trends (consumption & investment)
None of which is preordained....
The lack of data consistency, the imbalance of GDP growth drivers and the magnitude of public and private debt add economic uncertainty to China's geopolitical challenges
Data consistency
Data consistency from one timeframe to the next with (quickly forgotten) adjustments to previous estimates are a familiar statistical exercise in all major economies
And China’s nominal GDP of 4.9% has raised more questions than usual
Albert Edwards (Société Générale) highlighted the very liberal use of the GDP deflator, an adjustment used to remove inflationary effects to nominal data or – in the current Q3 growth estimate – to adjust the data for deflationary impact by adding a 1.4% deflator to a weak nominal 3.5% GDP to reach the 4.9% ‘growth’
In principle, the deflator facilitates comparisons between data cycles
But for Edwards, China’s statisticians cannot have it both ways
- Either the deflator was plugged in for political convenience but then, nominal GDP is in fact quite weak
- Or the deflator, which was only be as high in 2010, during the Great Financial Crisis, signals truly deflationary trends in the Chinese economy
Neither conclusion is enticing
Economists like Louis Kuijs of S&P Global Ratings add grist to the mill by flagging government data revisions and price adjustments adjusting weak industrial sector prices by deflator, as part of producer price index calculations
As noted by Asia Times, China reported its largest-ever reduction in the value of monthly exports, a tweak that could mask weakness in trade amid softening global demand. That statistical tweak means activity this quarter is being measured from a lower base, making annualized comparisons appear more robust.
At 4.9%, the third quarter GDP growth will probably be reviewed next quarter and the questions surrounding actual growth strongly suggest persistent uncertainly about the impact of China’s stimulus measures
Between a rock and a hard place
Strong interest of China's leadership in legible and verified statistics is beyond doubt as precondition to set the economy on a sustainable growth path
However, in a balancing act, political pressure has countered with great persistence the societal benefits of an invigorated market economy, defined by private property and price discovery
The attempts to make the best of markets aligned 'with Chinese characteristics' have resulted in often awkward compromise, leaving deal-breaking final decisions on business affairs to political overlords
Statistical mush, the overcooked product of political meddling in neutral economic readings, is a regrettable, and also one of the more obvious, consequences of interference
Unreliability of China's statistical projection of the economy has been a familiar trope for decades, to smooth unacknowledged slumps (sometimes), or to reach official growth targets (always)
- in 1998 when a 2% contraction was reported as a 7.8% increase, and again in 1999,
- or in 2005 with a 17% adjustment upping the previous statistics,
- or in 2007 when Li Kequiang (then head of the Liaoning province, to become premier from 2013 to 2023 and recently deceased) confirmed with a smile that GDP numbers were 'manmade' and 'for reference only'
Statistical adjustments and alterations, in one direction only, cannot be easily corrected after decades of obfuscation
The trap is set - it is a mathematical prison of 'past data inflation'
Structural factors of imbalance
The statistical record of the Chinese economy might be futile in absolute numbers
However....
The relative weights of the economic GDP drivers are reliable indicators of growth characteristics, in a macroeconomic framework
GDP growth is nothing but the sum of retail consumption and investment (a mix of private and public expenditures), with a small net export factor thrown in
While the attention of commentators is riven on growth as a data point, the balance between the sources of economic growth alone really matter over time
Imbalance will be a cause of concern
Retail consumption - at 54% of GDP on average - regains its footing in the aftermath of the COVID crisis and with the usual reservations on statistics, the third quarter retail consumption data signal strong retail sales
But attention should focus on the exceptionally high savings rate in Chinese households, a stubborn roadblock to a balanced growth pattern in the long run
As discussed in ‘a broken growth model’, the Chinese households' savings rate at 23-25% of GDP is triple the worldwide average (7-8%)
Whatever the prevailing structural motive may be, rooted in demography, in economic inequality or in cultural traits, old age insecurity, income inequality or housing affordability among others, prudence in spending is here to stay and consumption stagnation is a reality…
And high youth unemployment, at 21.3% last June, before China stopped communicating on the data, does not look supportive of consumption going forward
Exports are dependent on economic strengths of foreign retail markets
Exports are a booster in terms of employment, as growth driver and as source of foreign currency, but after netting imports (17.5% of GDP), 20.5% exports represent just 3% of GDP
According to latest data, reduction in the value of monthly exports may signal soft global demand but the weakening yuan currency rate, sinking to a 16-year low versus the US dollar, is a positive, if geopolitics do not get in the way...
Government investment spending is expected to remain on track, if only because the comfort of direct control, and a well-trodden habit of Keynesian capital spending to boost the economy, are predictable
But the financial frailty of local governments fosters uncertainty in the size of public infrastructure expenditures, as GDP driver
Debt loads come to the fore - and are not about to leave the front stage
It all comes down to real estate
Real Estate – between 25% and 30% of GDP – is the weakest link in China’s growth model and a large chunk of the country's investment share in total GDP (40% to 45%)
The collapse of the two largest real estate operators - Evergrande and Country Garden - has been a brutal reminder of necessary prudence, dictated belatedly by the Chinese regulator with the "five red lines" targeting excess in leverage
The need to reign in real estate expansion was undisputable, but heavy-handed financial rulings to constrain debt uptake all but ignored interconnectedness between the sector's dynamism, local governmennt finances and households' asset valuation
China’s growth model relied in large part on expansion of the real estate sector, which itself relied on debt
This is how Country Garden recorded more than $180 billion in liabilities as of June 2023 and Evergrande had debts amounting to more than $300 billion, debts - extraordinary numbers which still must be compounded by off-balance sheet debt for unknown amounts....
China’s real estate really was, and remains TBTF – "too big to fail writ large"
Free of market stabilizers, the sector's access to domestic and international lending facilities was unconstrained, under the mistaken assumption that the main operators were indeed too big to fail
As for the Chinese households, lacking alternative options for their savings, they provided unwavering support for continued expansion of the real estate sector
The presumed 'safety' of real estate investments, with a long record of rising value, stood out as a much-needed safe haven
- A central bank (People's Bank of China) survey of urban households conducted in 2019 revealed that the value of housing composed 59% of households’ total assets, while mortgage loans stood at 12% of total assets (similar to the US on the eve of the subprime mortgage crisis in 2008 and to Japan before the bursting of the real estate bubble)
- The mounting risk of overbuilding was ignored : the number of unsold appartments were estimated at 7.2 million last August '23
More critically still, even if the depth of the crisis is not yet entirely apparent, the inevitable downsizing of the real estate sector precipitates a chain reaction in China's growth model
Passing the hot potato
There is broad agreement about a public (government) debt in relation to GDP at around 77% (2022), projected at 83% for the current year 2023
And Chinese officials stress the ratio's alignment with indebtedness in advanced economies - between 104% and 122.5% (IMF 2022)
However, although the debt ratio may be correct in a narrow sense, it is missing two key points
- very sharp increase in indebtedness since 2000, as shown by official statistics (residential debt grew 9 times and local government debt 6 times)
- in 15 years, since the Great Financial Crisis of 2007, China's total debt-to-GDP as doubled to 280%, again according to official data
To complicate financial options for economic and monetary authorities further,
actual local government debt is huge by any measure at 80 trillion yuan ($11 trillion) - more than 60% of China's annual GDP - of which 54 trillion yuan ($7.5 trillion) are interest-bearing , mostly owed to Chinese bank, according to Reuters
Local debt is carried in LGFVs, Local Government Financial Vehicles, separate from local budgets
- adding a layer of uncertainty about true debt levels
- and adding factors of instability because financial strengths of local governments are very unequally distributed between wealthy coastal regions and poor frontier governments
Because liabilities (debt) are assets of other entities, size and imbalance of local government debt shape the better part of the Chinese growth model
- exposure of the Chinese banking system is large and growing
- troubled economic prospects of the real estate sector deprive the LGFVs of a key resource, the sale of land for new housing developments
To engineer growth under the circumstances, recent policy announcements are sensible
- Implicitly, growth projections are lowered
- Local government debt payments are delayed, or transferred to the banking system, case by case
- Central government is taking on additional debt with bond issues
Hit by two overlapping crises - a debt crisis and a structural imbalance disrupting the growth model - China is seeking to douse the flames of debt running wild, leaving structural issues for later
In theory, the choice, while tactical only, is sensible : by alleviating local government debt, regional investment capability can once again be called upon to support domestic growth
With real estate on life support, lowly domestic consumption and exports facing an uncertain future, the outlook is stlll not a happy one
The central government is cautious in addressing the magnitude of domestic economic challenges today, and rightly so
But structural growth will have to be rebalanced going forward to count as a true measure of success