China is getting a diminishing growth bang for its credit buck

First-quarter GDP figures seem at first blush to be in sustainable territory but credit creation numbers show a different story

PUBLISHED : Tuesday, 16 April, 2013, 12:00am
UPDATED : Tuesday, 16 April, 2013, 5:24am


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Yesterday's release of China's first-quarter growth figures came as a shock to the financial markets.

Gross domestic product in the first three months of the year was up by just 7.7 per cent compared with the first quarter of last year.

Private sector economists had been expecting a growth rate of 8 per cent or more.

After the publication of the weak first-quarter number, several promptly downgraded their forecasts for the rest of the year. Louis Kuijs at RBS, for example, revised his growth forecast for 2013 down from 8.4 per cent to 7.8 per cent; the same rate as 2012.

The weak number was clearly a disappointment for Hong Kong investors, who had been pinning their hopes on a pickup in activity on the mainland. The city's benchmark Hang Seng Index slipped 1.4 per cent in response.

On one level, however, China's first-quarter growth figure should have been encouraging.

Growth of 7.7 per cent, after all, is not so far off Beijing's target of a sustainable 7.5 per cent rate.

What's more, the components of China's first-quarter growth were more in line with what policymakers would like to see than the growth mix in previous quarters.

Domestic consumption was the biggest driver of growth, contributing 4.3 percentage points of the 7.7 per cent headline figure. Investment provided just 2.3 percentage points - down from 3.9 percentage points in 2012 - with net exports making up the balance.

At first glance that mix makes it look as if China is successfully rebalancing away from investment-powered growth and more towards consumption as the engine of economic development.

On another level, however, China's soft first-quarter growth looks alarming. Over the last four quarters new credit creation - as gauged by Beijing's total social financing measure - has been running at almost 80 per cent of China's GDP.

That's considerably higher than China's pre-crisis levels of 50 to 60 per cent. Yet, as the first chart shows, although credit creation has surged, growth rates have tailed off.

In other words, these days China is getting less growth bang for its credit buck.

An increasing number of observers worry that's unsustainable, and a sure recipe for a future financial crisis.

Four weeks ago Monitor reviewed the bulls' arguments for investing in gold.

With Cyprus in crisis, there was diminishing confidence in the safety of European bank deposits.

There were the mounting geopolitical tensions in Asia. There were supply constraints. And above all, there were the world's leading central banks, apparently intent on debasing their currencies by printing unlimited quantities of new money.

All these factors, argued the bulls, would combine to drive a new rally in the price of gold as a safe haven investment.

Monitor wasn't convinced, noting that none of these arguments was new, and pointing out that if quantitative easing were to work, equities would be a more attractive investment than gold.

"The arguments in favour of gold aren't as compelling as they seem at first," Monitor concluded.

It seems the market agrees. With investors cashing out of exchange-traded funds that hold gold, the metal's price has slumped by 13 per cent in the intervening four weeks.

Yesterday alone gold crashed almost 10 per cent, at one point falling to US$1,385.55, its lowest in two years.

No doubt that fall owed something to the weak Chinese growth figures. So if you still believe in China's economic recovery, perhaps this would be a good time to buy gold as a bet that all that credit creation will drive a pickup in growth later in the year.