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China: A (Re)Balancing Act

China has suffered from misplaced fears for some while. Some thought the economy would be in recession by now, after a stockmarket crash and unexpected renminbi depreciation last year. Others have warned that the re-balancing of China’s economy also means inevitable recession. And yet others have predicted a Lehman-style financial crisis due to too much debt.

China has proved the pessimists wrong so far and will likely continue to do so. To be sure, there are problems but they look manageable.

Last week’s data showed that the economy grew by 1.8% qoq, 6.7% yoy in the second quarter, considerably better than quarterly growth of 1.2% in the first quarter. True, the numbers are not great quality but they are credible enough.


The government has halted the late 2015/early 2016 slowdown, thanks to extra public sector spending, lower interest rates, easier bank capital requirements and a weaker currency. However, it has been a balancing act between supporting growth and a delay in transforming the economy from the old manufacturing/export model to the new services/consumption one.

In its latest review, the IMF congratulated China on making progress in switching from industry to services and in freeing up its financial markets but specifically listed credit growth, corporate governance and state-owned enterprise (SOE) reforms as areas to tackle.

Here are a couple of (related) worrying signs from recent data. First, although investment spending was up 9% yoy year-to-date in the first half, private sector capex rose just 2.8% compared with state capex 23.5%. In other words, the government has stepped in to ease the effects of a very steep slowdown in private capex.

Second, M1 growth was 24.6% yoy in June versus broader M2 growth of 11.8%. This suggests that Chinese firms are building up cash deposits at a rapid rate which they are not keen to spend. The slowdown in capex and the run-up in cash suggest that either firms lack confidence or they have few worthwhile investment projects on their radar.

In some industries – coal, steel and housing, for instance – there is over-capacity which makes investment pointless. Elsewhere – for example, finance, energy, telecoms and transport – private firms are being crowded out by SOEs. We worry less about too much SOE debt, which seems to be largely owed to SOE banks, but more about inefficient state firms holding the economy back.

Looking ahead, we see the following:

  • Growth will remain in a 6%-7% range over the next 18 months … we would not be any more precise than that.
  • Inflation – 1.9% in June – will remain low in line with the rest of the world.
  • The government will shift back towards rebalancing the economy and away from supporting growth
  • SOE reforms are crucial so we shall follow the news wires for progress
  • Asia-Pacific equities have had a very strong 12 months in GBP total return terms … they remain good value and attractive

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