Tuesday, July 16, 2013

Vital signs from China

All eyes in global markets are turning to China. The release of its June quarter GDP later today will be big news, whatever the result. The consensus forecast is for annual GDP growth of 7.5 per cent but the bigger story and source of speculation will be where the Chinese economy is heading in the second half of 2013 and into 2014.

With the US recovery not only assured, but the risks brewing that this time next year growth will be above 3 per cent with the unemployment rate below 7 per cent, perhaps the biggest threat to global markets and economic stability over the next 12 months is not the US, but what is happening in China.

In the last week or so, the Chinese government has been signaling that GDP growth will slow further in the near term with one official growth forecast over the weekend at around 7 per cent. The outlook, from the country's finance minister, Lou Jiwei, was later corrected to "7.5 per cent" in reports from official news agency Xinhua. But China has not recorded such a low growth rate since 1990, and this is where the market nervousness is no doubt based.
In itself, this is seen as some form of hard landing. A 23-year low for GDP growth certainly reinforces that impression.

As noted last week when looking at the lift in Chinese inflation, the most recent government five-year plan, set in 2011, had a projection for GDP growth of 7 per cent (Hod to read inflation in Chinese, July 10). Given the economy is on track to meet that target in 2013 from a stronger pace previously, one might argue that the faster rate of expansion in 2012 was a bonus and what we are seeing now is a more mature Chinese economy registering what will become the new normal for the next decade or so.

In terms of global pressures from a less rapid growth path for China, it should be noted that 7 per cent GDP growth now is a much more powerful stimulant than was 12 per cent growth in the early 1990s. The maths are simple. In the early 1990s China's annual GDP was a little over $US1 trillion, meaning 12 per cent GDP growth was adding no more than $120 billion a year to global growth. Fast forward to today where China's annual GDP is over $US8 trillion, and a 7 per cent growth rate adds nearly $US600 billion a year to the global economy.

Viewed another way, per capita GDP in 1980 in China was around $US310 per annum. The people were exceedingly poor. It edged up to $US344 per annum in 1990 and since then it has surged. By 2000, per capita GDP had trebled to $US1042, it doubled again by 2006 and doubled yet again by 2010 to $US4434. Preliminary estimates suggest that per capita GDP was around $US6100 in 2012 and it is on track to exceed $US10,000 by 2020.
This highlights not only the spectacular rise of the Chinese economy but also the fact that China is now going through a transition phase. As China's national income and GDP per capita reach a higher level, the scope for growth diminishes.

That time is about now.

Structural changes in China over two decades mean that the potential growth rate is less rapid and there is no doubt that this message will slowly but surely be understood in the markets over the months and then years ahead.

For now, the obvious structural change is also being met with a cyclical cooling in activity.

The recession in Europe is hurting China's manufacturing sector. China's biggest export market is in fact the eurozone, which has been showing up in somewhat disappointing Chinese export data in recent times. This is likely to be a key factor behind the growth moderation that will be evident in today's GDP result.

At the same time, there is a property glut which means a period of weaker activity in that sector is needed before the excess supply is cleared.

For Australia, what happens in China is vitally important – which is why the markets will be nervously watching the flow of news.

In the short term, that news could be a little disappointing but longer term, there seems little doubt that the Chinese economy will remain a global powerhouse. It will be the main driver of global growth and will have a huge appetite for commodities. It is just that the GDP growth rate will seem less impressive, even though in three years China will be only the second country in the world (behind the US) to have annual GDP in excess of $US10 trillion.

Australia should feel well pleased that more than a quarter of our exports go to such a dominant economy, even if its growth rate is a little less rapid.


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