IHS Global Insight Perspective
Gross domestic product (GDP) in real terms expanded 6.1% in the three months through March, but signs of improvement in the economy were apparent towards the end of the quarter.
Growth has been emasculated by a collapse in exports that has fundamentally undermined industrial output growth. Authorities have responded with aggressive fiscal and monetary stimulus that appears to be generating internal demand focused in investment growth. However, although such measures will boost growth over the short-term, the policy could be fomenting significant risks over the long-term.
The growing signs of a bottoming out of growth in the first quarter are in line with IHS Global Insight's revised April forecast that calls for growth of 5.9% in 2009. The depth and duration of the slump in global demand remains the main caveat in that outlook.
Hitting the Nadir?
The Chinese economy braked to its lowest growth in recent history in the first quarter of 2009. Official data released Thursday showed that gross domestic product (GDP) in real terms expanded 6.1% on the year. The outturn stood in stark contrast to the surging 10.6% annual growth recorded in the corresponding period of 2008. The first quarter growth rate also marked a deceleration on the 6.8% annual gain recorded in the fourth quarter of 2009.
The Export Shock
Although the economy has steadily shed momentum since the second half of 2007, growth fell off a cliff in the closing stages of last year as external demand collapsed. Exports account for around 40.0% of GDP and provide the major underpinning to industrial output growth. The retrenchment in external demand has been closely shadowed by industrial output. Indeed, the weight of exports in growth has actually increased since the 1997-98 Asian financial crisis, as growth in domestic consumption has proved stunted. Compared with the outset of the Asian Financial Crisis in 1997, when exports accounted for 19% of China's GDP, Chinese exports' share of GDP rose to 36% by 2007. The economy's exposure to fluctuations in global demand has become more acute, exacerbated by the concentration of exports in shipments to the United States, Europe, and the rest of Asia
Total trade in the first quarter shrank by 24.9% on the year. Exports in value terms contracted 19.5% year-on-year (y/y) to US$245 billion. The stalling of global growth was also evident in foreign direct investment inflows; with actual utilised FDI declining US$5.6 billion over the three-month period from a year ago to US$21.8 billion. However, the trade surplus actually increased despite the continued attrition in exports, as import growth turned sharply negative. Imports are dominated by inputs for the country's manufacturing processing platform—with parts and components sourced predominantly from the Asia region—and by raw materials. The reversal in global commodity prices in the second half of 2008 has had a marked impact on import growth in nominal terms, particularly given the high comparison period of the corresponding period last year. In the March quarter, imports tumbled 30.9% on the year to US$183.2 billion. The resultant US$62.3 billion trade surplus stood as a US$20.9 billion increase over the previous year.
Industrial output subsequently atrophied, averaging growth of 5.1% in the first quarter. The aggregate profits of producers also tumbled, falling 37.3% on the year to 219.1 billion yuan (US$42.6 billion). Chinese manufacturers typically rely on high volumes of low-cost goods to generate earnings, accentuating the impact of falling demand on their bottom lines.
Massive Macro-Economic Stimulus Begins to Feed Through
To counter the negative reverberations of the export slump, authorities have implemented aggressive macro-economic stimulus measures. Leading interest rates have been cut five times since the middle of September 2008 by a cumulative 216 basis points, while the availability of credit has expanded rapidly since the beginning of 2009 as the financial system has been flooded with liquidity. The broad money supply was expanding at a rate of 25.5% on the year as of end March, 7.7 percentage points higher than in the same period of 2008. In the four months between December 2008 and March 2009, total loans rose by an astounding 5.4 trillion yuan, more than triple the loan increase in the same period 12 months earlier. To stimulate growth on the demand side, the government has unleashed a mammoth four-trillion-yuan emergency budget with measures targeted at supporting employment growth through huge infrastructure projects and jump-starting private consumption to absorb excess export supply. Finally, a slew of administrative measures have also been implemented to support the corporate sector, including increases in export tax rebates and tax concessions for beleaguered sectors.
Outlook and Implications
The policy blitzkrieg has yielded some immediate success. Investment in fixed assets rose 28.8% y/y in the three months through March, accelerating from the 24.6% growth recorded in the corresponding period of 2008, when authorities were engaged in a reverse struggle to cool capital expenditures. Retail sales, a close proxy for private consumer spending, rose 15.0% in annual terms in the first quarter in nominal terms and by 15.9% in real terms. Real retail sales growth in the first quarter of 2008 weighed in at 12.3%. Furthermore, the overall first quarter industrial output figures mask a pick-up in momentum in March. In March alone, industrial output rose 8.3% on the year after aggregate growth of just 3.8% in January and February combined. The Purchasing Managers' Index, which began to improve in December, climbed into the positive, above-50 territory in March for the first time since September 2008.
However, despite the gradual traction in private consumer spending the incipient momentum in the economy is centred on fixed asset investment growth, which could foment risks over the medium-term. Although asset prices have experienced sharp corrections, Chinese consumers are buffered by high savings rates. Unlocking those savings is the focal point of policy. Yet, the key rests with long-term structural reforms to alleviate widening income gaps across the country, create adequate social welfare nets, and bolster the share of private enterprise in growth. Conversely, still heavy levels of state influence over the banking system has enabled rapid and concerted mobilisation of monetary stimulus. But with the massive loan growth mediated by state-controlled institutions with apparent scant regard for risk supervision, the potential for a fresh generation of non-performing loans emerging over the next five years remains significant. That risk is accentuated by the fact that the concentration of stimulus in investment is effectively adding more capacity to an economy already plagued by excess capacity prior to the downturn. Although the massive liquidity injections mitigate the risk of a major deflationary spiral, the high levels of surplus capacity in the economy will continue to undermine the pricing power of domestic firms, in turn eroding their ability to service rising liabilities as earnings fall. The potential for localised banking stress over the medium-term remains significant.Recent high-frequency data is building a composite picture that shows that growth probably bottomed out in the first quarter and will begin to gradually firm over the near-term as the huge stimulus feeds through the economy. IHS Global Insight, anticipating this trend, raised its 2009 growth forecast to 5.9% from 5.7%. However, significant caveats remain, not least the depth and duration of the downturn in major export partners. State-sponsored internal demand growth will provide some offset over the short-term but cannot be sustained indefinitely. Although the government has intimated that an additional fiscal stimulus package may be forthcoming, negative revenue growth in recent months circumscribes the government's room for fiscal expenditure on scales seen so far. China's economy may be being hauled out of the woods but if the slump in global demand extends beyond our current forecast horizon, which expects a bottoming out in the third and fourth quarters of the year, then authorities face a truly thorny situation.