Mixed opinions on China’s H2 economic outlook

Weakness in private investment, over reliance on state spending to boost growth, and ongoing buildup of debt continue to cause concern

PUBLISHED : Tuesday, 26 July, 2016, 8:06pm
UPDATED : Tuesday, 26 July, 2016, 10:54pm

Some of the world’s top finance houses appear split on their projections for China’s economy in the second half of the year.

But the general consensus remains gloomy longer term, suggesting that the better-than-expected second quarter economic growth will peter out early next year, bringing to an end what has been a mini-cycle improvement since the third quarter of last year.

The analysts also predict, that weakness in private investment and over reliance on state investment to boost growth could add to the ongoing buildup of debt — all of which casts considerable doubt on China hitting its targeted 6.7 per cent growth in GDP for the second half.

Despite the Chinese government’s better-than-expected GDP growth announcement earlier this month, Credit Suisse is now forecasting 6.3 per cent growth in the second half, based on a drop in overall investment in the economy.

Growth will continue to be underpinned, it said, by resilient consumption.

Disappointing growth in fixed asset investment of 8.1 per cent in the second quarter and 7.4 per cent year-on-year in June should intensify in the second half
Credit Suisse analysts Ray Farris and Weishen Deng

“The bad news is that the disappointing growth in fixed asset investment of 8.1 per cent in the second quarter and 7.4 per cent year-on-year in June should intensify in the second half,” its analysts Ray Farris and Weishen Deng said in a recent note.

Official Beijing government data shows growth in capital spending from private investors slowed to 2.8 per cent in the first half from 3.9 per cent in the first five months, while state sector investment rose 23.5 per cent.

“This emphasises the economy’s increasing dependence on government stimulus for growth,” said Farris and Deng.

JP Morgan, however, is less optimistic on the effects of consumption, adding that the momentum in growth “may not be able to fully offset the ongoing deterioration in private and manufacturing investment”.

Morgan Stanley, meanwhile, has also adjusted its forecasts down to 6.4 and 6.2 per cent for the rest of this year, following the sharp deceleration in manufacturing and private investment growth in the first half, in comparison to strong state investment.

Its economists Robin Xing, Junwei Sun and Jenny Zheng emphasised, particularly, that the surge in state-owned enterprise investment on infrastructure and property projects has only exacerbated the country’s debt overhang, and risks reducing overall efficiency in the economy.

“We expect the country’s debt-to-GDP ratio to rise throughout the coming years,” Morgan Stanley economists wrote.

JP Morgan global market strategist Marcella Chow also argues that stronger-than-expected second quarter data pointed to growth stabilisation, and could offer comfort, amid still elevated levels of global uncertainty.

Chow added, however, that “as the impact of earlier rounds of stimulus start to fade and immediate policy easing seems unlikely to materialise, we expect GDP growth to ease modestly in the second half of 2016”.

Elsewhere, S&P Global Ratings remains more optimistic than the US investment big guns, raising its annual growth forecast by about 0.25 percentage points from its previous forecast to 6.6 per cent for the second half of this year, following upside surprises in growth in the last quarter.

Its Asia-Pacific chief economist Paul Gruenwald cautioned, however, that the higher growth forecast does not mean the overall health of the Chinese economy has improved.

“Instead, it shows we overestimated the authorities’ appetite for slower GDP growth, as the price [they had to pay] for improving medium-term financial sustainability,” he said.

According to Morgan Stanley, China’s policy makers have used credit-fueled investments to offset weaker external demand and boost domestic demand growth, causing an aggressive pick up in leverage in China over the past eight years.

There is a high risk of much slower growth over the medium term triggered by the expanded debt burden and falling returns on investment
Morgan Stanley analyst

Its analysts say China’s overall debt-to-GDP ratio has picked up by 112 percentage points from 147 per cent in 2007 to 260 per cent in 2015, as policy makers tried to bolster demand growth through government investment.

“As a result, there is a high risk of much slower growth over the medium term triggered by the expanded debt burden and falling returns on investment,” they added, despite initially higher GDP growth.

This is a consequence, they said, of China’s “slow adjustment” approach, which involves the use of government stimulus policies to keep growth at around 6.5 per cent to meet President Xi Jinping’s target of doubling ‘s 2010 GDP by 2020.

But in order to maintain that 6.5 per cent growth target and make structural adjustments at the same time, Morgan Stanley said policy makers are likely to swing between demand stimulus, and supply-side reform.

Both Bank of America Merrill Lynch and Morgan Stanley note there has been reduced policy support and little incentive for policy makers to adopt easing measures, given the strong recent data and high cost of stimulus.

“This is reflected in the deceleration in M2 growth (a measure of money supply) and property tightening in overheated cities,” Morgan Stanley said.

The bank also forecasts two more rate cuts by the People’s Bank of China, of 25 basis points each, towards the end of the third quarter of 2016 and the first quarter of 2017.

Even with a potentially marginal lift from the ongoing yuan depreciation, analysts have also lowered their expectations for export growth, due to weak private capital expenditure, increased uncertainty post-Brexit and political turbulence.

BoAML economists Helen Qiao, Xiaojia Zhi and Sylvia Shen said that “global demand is too weak for to reap much benefit from currency depreciation”.

“We expect no pickup in external sector investment, while excess capacity possibly prevents Chinese exporters from pocketing much gain from a weaker yuan.”