Sunday, January 20, 2013

China turns the corner

At the end of last year we anointed 2012 as the year of the “crisis averted”.  One of the things markets were worried about as 2012 progressed was the possibility of a hard landing in China.  While the world’s second largest economy slowed further and for longer than we initially expected, December quarter GDP confirmed the turnaround evident in recent activity data that the economy reached the low point in the cycle the September 2012 quarter and posted a modest improvement in the year to December.

China GDP growth rose from 7.4% in the year to September to 7.9% in December.  Data for industrial production, retail sales and fixed asset investment all came in stronger than expected.  That’s on top of last week’s better-than-expected export data.  Exports can be volatile so we haven’t read too much into that result.  That’s why we tend to focus on three-month moving averages for the activity data.  But as you can see from the graph below, the turnaround is coming through most sectors to varying degrees.

Much of the improvement in GDP growth over the quarter was due to higher investment, most notably public works (railways).  That’s where much of the recent stimulus has been targeted and implementation was stepped up a notch in the second half of 2012.  The authorities have been cautious with stimulus with the current fiscal package well shy of that introduced during the Global Financial Crisis.  As it has turned out, much of the slowdown in GDP growth over the previous 7 quarters has been structural simply by virtue of the fact the authorities have been happy to see some of the recent excesses (residential property, local government) in the economy reduced.

With inflation now also appearing to have turned the quarter (year to December CPI inflation rose to 2.5%) albeit largely due to the impact of bad weather on food prices, authorities will be even more cautious about stimulus.  It seems a safe bet to assume that interest rates are now on hold.  The new leadership may well look to continue to boost fiscal spending, but we expect that will remain modest, at least compared to the post-GFC period.

That means we contine to see an only modest recovery in China growth in 2013.  Annual average growth came in at 7.8% last year.  We are currently forecasting 8.0% for 2013.  That might look a bit light now but I'm happy to leave it where it is at the moment.  But isnt it nice to be contemplating upside risk to GDP growth for a change?

China still faces a significant challenge to maintain reasonable growth and rebalance its economy in the face of structural challenges.  Data also released last week showed a decline in China’s working-age population for the first time.  That’s a result of population control policies such as the one-child policy.  That supports our view that despite the current cyclical rebound, China remains on a pathway to lower trend growth.

Also if consumption is to rise as a proportion of a growing economy, incomes must rise as well.  That makes reforms to boost productivity essential in order to keep inflation in check.  Otherwise efforts to rebalance the economy will ultimately prove to be unsustainable.

In the meantime, improving China GDP growth supports our view of a modestly improving global growth environment in 2013 which will see higher New Zealand trading partner growth.  That’s good for export volume growth (agriculture growing conditions permitting) and commodity prices.  Such a environment will, however, continue to lend support the New Zealand dollar.