本文发表在 rolia.net 枫下论坛China: Sharp Slowdown Ahead
Andy Xie (Hong Kong)
The Chinese economy is likely to slow down sharply next year. It is now growing at the fastest pace in ten years. Electricity consumption has grown at 14.9% on average for the past five quarters versus an average of 7.9% in the 1990s. We believe that the economy will revert to normal growth rates next year.
We expect growth rates for the export and property sectors to halve next year. Exports have been growing at 30% YoY this year and could decelerate to 15% next year, as foreign direct investment decelerates. Commercial property under construction is likely to rise by 26% this year to 1,170 billion square meters. Inventory in the property sector appears to be rising rapidly and selling prices falling. We believe that this sector could grow by 10% next year at best.
Our current GDP forecast for 2004 is 7.8%. This is still compatible with our current view. We are marking up this year抯 growth rate to 8.5% to be in line with government guidance.
Exhibit 2
China: Economic Forecast Summary
YoY, %, unless otherwise stated 2001 2002 2003E 2004E
Real GDP 7.3 8.0 8.5 7.8
Nominal GDP 7.3 6.7 10.7 7.9
Private Consumption 7.0 5.7 6.0 8.5
Public Consumption 11.3 6.1 5.0 7.0
Fixed Investment 12.8 14.5 22.8 11.1
Net exports, % of GDP 2.3 2.7 1.0 -0.1
Current account, US$ bn 17.4 35.4 15.3 -0.1
% of GDP 1.5 2.9 1.1 0.0
Trade Balance, US$ bn 22.5 30.4 10.0 -9.2
Exports 6.8 22.3 30.0 15.0
Imports 8.2 21.2 40.0 20.0
CPI 0.7 -0.8 0.7 0.5
E = Morgan Stanley Research Estimates
Source: CEIC, Morgan Stanley Research
Credit and Export Are Accidentally Firing Together
Debt-funded investment and exports drive China抯 economy. Both have been exceptionally strong, generating the turbo-charged economic growth of the past five quarters. Normally, China tries to stagger investment and export growth in order to smooth economic growth. For example, China accelerated debt-funded infrastructure investment in 1998 to compensate for the export slowdown. Credit expansion slowed in 1999 as exports recovered strongly.
However, during the past seven quarters credit and exports have been surging simultaneously. The banking system began to increase lending rapidly at the beginning of 2002, probably to foster a strong economy for the leadership transition between 4Q02 and 1Q03. Total bank lending to the non-financial sector increased by about 50% (about 53% of 2002 GDP or US$693 billion) between 1Q02 and 3Q03. In addition, the banking system also increased lending to non-monetary financial institutions by another 10.3% of 2002 GDP (or US$133 billion).
Gross capital formation was US$509 billion in 2002 and US$414 billion in the first three quarters of 2003. The loan increase was equal to 89% of the total fixed capital formation during this period. Since depreciation is about 25% of gross capital formation, the bank loan increase in the past seven quarters has funded every dollar in fixed investment and more. It is consistent with the perception that the existing capital base generates very little fresh cash. Thus, if bank lending slows, investment will slow.
The strong FDI inflows seen since China joined the WTO have significantly boosted the country抯 export capacity. The cyclical recovery in the global economy has allowed the increased export capacity to be fully utilized. China抯 exports are likely to increase by 30% or US$100 billion (7.7% of 2002 GDP) this year. China is thus reaping the benefits of joining the WTO.
Fixed investment is also likely to rise by 30% (12% of 2002 GDP). Combined, these two growth drivers could grow by the equivalent of 19.7% of 2002 GDP. The incremental ratio of export plus fixed investment to GDP averaged 0.62 in the 1990s, ranging between 0.5 to 1.0. This ratio was 1.1 last year and could reach 2.4 this year if the official statistics are to be believed. It is certainly difficult to measure this increase when the GDP structure is changing rapidly. There is enough evidence, however, to suggest that the economy could be growing as rapidly as demand for electricity.
Sharp Slowdown Ahead
Both export and fixed investment growth could halve in 2004. China抯 exports are driven by production relocation as reflected in the FDI inflows and the global cycle. On the structural production relocation, FDI inflow appears to be slowing from a very high base. This should not be surprising after the exceptionally strong growth of the past three years, following China抯 entry into the WTO, as the multinational corporations modified their business planning to accommodate China抯 membership. While China will likely continue to gain market share in global capital allocation due to its low cost, the one-time jump due to its entry in the WTO is winding down.
Chinese exports are a lagging indicator to FDI. The recent deceleration in FDI thus indicates an export slowdown ahead. We were predicting a 20% export increase for 2004. We now think that 15% is more likely. That represents a 50% reduction in export growth from this year.
Further, the three percentage points of reduction in VAT rebates for exporters could decrease their net profits by 8-10%. Such a large decline in profitability will likely reduce incentives for export production. Shifting one quarter of the VAT rebate burden to local government would also reduce the ability of local governments to attract investment for exports. It may have a bigger impact on export production than the rebate reduction itself.
Cyclically, the global economy may have peaked in 3Q03. While the growth rate would still be relatively robust until 3Q04, the growth rate in 3Q03 was boosted by a post-SARS rebound in Asia and 6% plus growth rate in the US.
Fixed investment should slow with credit. The government has announced measures to slow credit growth. Even without tightening measures, credit growth would have decelerated on factors related to a high base. There are signs of rising inventory in the property and commodity industries. Data on inventory are spotty and usually not accurate. The official statistics show 311 million square meters of unsold but finished properties between 1998 and 2002, more than one year抯 total demand. While this number may appear too large, falling prices and rising vacancy rates in major markets suggest a significant inventory overhang.
There are also signs of industrial commodities inventory building up in the distribution channels. Metal prices have been rising in China, and thus distributors have an incentive to pile up supply to speculate on price appreciation. This happened during the 1992-93 investment boom, and caused industrial commodities prices to decline sharply during the subsequent credit slowdown. It is possible that the same scenario will be repeated next year.
Credit expansion to fund inventory accumulation for speculative purposes evaporates when prices decline. Property prices are already declining in a number of major markets. Metal prices are peaking and could decline sharply in the next six months. Steel prices, for example, could decline by 15% within six months, in my view. Declining prices due to excessive inventory would deter bank lending.
Exhibit 2
Inventories Could Be Building Up in Channels
--------Steel------ ---Aluminum--- Auto Commercial
Produ. Import Produ. Import Property
(ton mn) (ton mn) (mn) (mn sq m in produ.)
1986 52
1993 89 33 0.3 0.9
1998 114 12 0.6 1.6 481
1999 124 15 1.7 1.0 1.8 551
2000 126 16 2.1 1.4 2.1 635
2001 143 17 2.3 0.9 2.3 772
2002 180 24 2.7 1.1 3.2 928
2003E 217 36 3.6 1.4 4.3 1,179
Source: CEIC.
Note: 2003 data are extrapolation of the first nine month data for production and first eight month data for imports.
Is Credit Tightening Real?
The market has questioned the Chinese government抯 resolve to slow credit expansion, believing that either the government has lost control over credit expansion or it doesn抰 mean what it says. Both are wrong, in my view. The four state banks accounted for 71% of the increase in household savings deposits but only 45% of the increase in lending to the non-financial sector between 1Q02 to 2Q03. The current credit boom is dependent on state bank lending to regional and local banks through the interbank market. There are indications that interbank liquidity has dried up, and the local and regional banks are no longer increasing lending given the lack of funds.
In the real economy, signs of credit distress are popping up. There are frequent complaints that the 慺inancing chain?is broken. A large number of companies in China depend on increasing investment to cover cash shortages associated with bad investments in the past, and their survival totally depends on accelerating credit expansion. I expect a large number of companies could be under severe pressure going forward.
Why should the government tighten? China does not suffer from inflation. Labor surplus and a high savings rate imply that China抯 potential growth rate is substantially above 10%. Thus, the current growth rate may not be excessive. However, China抯 financial system has trouble allocating capital effectively. The misallocation tends to escalate when economic growth is rapid. For example, bad debts could be growing faster than GDP in the current environment, which would cancel the benefit of high growth for the country and may lead to a financial crisis. Thus, the rationale for tightening is to keep bad debts from growing faster than GDP.
Lastly, the market also believes that the government is unable to stem strong capital inflows that in turn boost lending. As has been seen in East Asia before, investment booms in the region are usually 慴ubbles?-- when local credit expansion causes an investment bubble, it tends to attract foreign capital. When it cools, foreign capital tends to leave.更多精彩文章及讨论，请光临枫下论坛 rolia.net
Andy Xie (Hong Kong)
The Chinese economy is likely to slow down sharply next year. It is now growing at the fastest pace in ten years. Electricity consumption has grown at 14.9% on average for the past five quarters versus an average of 7.9% in the 1990s. We believe that the economy will revert to normal growth rates next year.
We expect growth rates for the export and property sectors to halve next year. Exports have been growing at 30% YoY this year and could decelerate to 15% next year, as foreign direct investment decelerates. Commercial property under construction is likely to rise by 26% this year to 1,170 billion square meters. Inventory in the property sector appears to be rising rapidly and selling prices falling. We believe that this sector could grow by 10% next year at best.
Our current GDP forecast for 2004 is 7.8%. This is still compatible with our current view. We are marking up this year抯 growth rate to 8.5% to be in line with government guidance.
Exhibit 2
China: Economic Forecast Summary
YoY, %, unless otherwise stated 2001 2002 2003E 2004E
Real GDP 7.3 8.0 8.5 7.8
Nominal GDP 7.3 6.7 10.7 7.9
Private Consumption 7.0 5.7 6.0 8.5
Public Consumption 11.3 6.1 5.0 7.0
Fixed Investment 12.8 14.5 22.8 11.1
Net exports, % of GDP 2.3 2.7 1.0 -0.1
Current account, US$ bn 17.4 35.4 15.3 -0.1
% of GDP 1.5 2.9 1.1 0.0
Trade Balance, US$ bn 22.5 30.4 10.0 -9.2
Exports 6.8 22.3 30.0 15.0
Imports 8.2 21.2 40.0 20.0
CPI 0.7 -0.8 0.7 0.5
E = Morgan Stanley Research Estimates
Source: CEIC, Morgan Stanley Research
Credit and Export Are Accidentally Firing Together
Debt-funded investment and exports drive China抯 economy. Both have been exceptionally strong, generating the turbo-charged economic growth of the past five quarters. Normally, China tries to stagger investment and export growth in order to smooth economic growth. For example, China accelerated debt-funded infrastructure investment in 1998 to compensate for the export slowdown. Credit expansion slowed in 1999 as exports recovered strongly.
However, during the past seven quarters credit and exports have been surging simultaneously. The banking system began to increase lending rapidly at the beginning of 2002, probably to foster a strong economy for the leadership transition between 4Q02 and 1Q03. Total bank lending to the non-financial sector increased by about 50% (about 53% of 2002 GDP or US$693 billion) between 1Q02 and 3Q03. In addition, the banking system also increased lending to non-monetary financial institutions by another 10.3% of 2002 GDP (or US$133 billion).
Gross capital formation was US$509 billion in 2002 and US$414 billion in the first three quarters of 2003. The loan increase was equal to 89% of the total fixed capital formation during this period. Since depreciation is about 25% of gross capital formation, the bank loan increase in the past seven quarters has funded every dollar in fixed investment and more. It is consistent with the perception that the existing capital base generates very little fresh cash. Thus, if bank lending slows, investment will slow.
The strong FDI inflows seen since China joined the WTO have significantly boosted the country抯 export capacity. The cyclical recovery in the global economy has allowed the increased export capacity to be fully utilized. China抯 exports are likely to increase by 30% or US$100 billion (7.7% of 2002 GDP) this year. China is thus reaping the benefits of joining the WTO.
Fixed investment is also likely to rise by 30% (12% of 2002 GDP). Combined, these two growth drivers could grow by the equivalent of 19.7% of 2002 GDP. The incremental ratio of export plus fixed investment to GDP averaged 0.62 in the 1990s, ranging between 0.5 to 1.0. This ratio was 1.1 last year and could reach 2.4 this year if the official statistics are to be believed. It is certainly difficult to measure this increase when the GDP structure is changing rapidly. There is enough evidence, however, to suggest that the economy could be growing as rapidly as demand for electricity.
Sharp Slowdown Ahead
Both export and fixed investment growth could halve in 2004. China抯 exports are driven by production relocation as reflected in the FDI inflows and the global cycle. On the structural production relocation, FDI inflow appears to be slowing from a very high base. This should not be surprising after the exceptionally strong growth of the past three years, following China抯 entry into the WTO, as the multinational corporations modified their business planning to accommodate China抯 membership. While China will likely continue to gain market share in global capital allocation due to its low cost, the one-time jump due to its entry in the WTO is winding down.
Chinese exports are a lagging indicator to FDI. The recent deceleration in FDI thus indicates an export slowdown ahead. We were predicting a 20% export increase for 2004. We now think that 15% is more likely. That represents a 50% reduction in export growth from this year.
Further, the three percentage points of reduction in VAT rebates for exporters could decrease their net profits by 8-10%. Such a large decline in profitability will likely reduce incentives for export production. Shifting one quarter of the VAT rebate burden to local government would also reduce the ability of local governments to attract investment for exports. It may have a bigger impact on export production than the rebate reduction itself.
Cyclically, the global economy may have peaked in 3Q03. While the growth rate would still be relatively robust until 3Q04, the growth rate in 3Q03 was boosted by a post-SARS rebound in Asia and 6% plus growth rate in the US.
Fixed investment should slow with credit. The government has announced measures to slow credit growth. Even without tightening measures, credit growth would have decelerated on factors related to a high base. There are signs of rising inventory in the property and commodity industries. Data on inventory are spotty and usually not accurate. The official statistics show 311 million square meters of unsold but finished properties between 1998 and 2002, more than one year抯 total demand. While this number may appear too large, falling prices and rising vacancy rates in major markets suggest a significant inventory overhang.
There are also signs of industrial commodities inventory building up in the distribution channels. Metal prices have been rising in China, and thus distributors have an incentive to pile up supply to speculate on price appreciation. This happened during the 1992-93 investment boom, and caused industrial commodities prices to decline sharply during the subsequent credit slowdown. It is possible that the same scenario will be repeated next year.
Credit expansion to fund inventory accumulation for speculative purposes evaporates when prices decline. Property prices are already declining in a number of major markets. Metal prices are peaking and could decline sharply in the next six months. Steel prices, for example, could decline by 15% within six months, in my view. Declining prices due to excessive inventory would deter bank lending.
Exhibit 2
Inventories Could Be Building Up in Channels
--------Steel------ ---Aluminum--- Auto Commercial
Produ. Import Produ. Import Property
(ton mn) (ton mn) (mn) (mn sq m in produ.)
1986 52
1993 89 33 0.3 0.9
1998 114 12 0.6 1.6 481
1999 124 15 1.7 1.0 1.8 551
2000 126 16 2.1 1.4 2.1 635
2001 143 17 2.3 0.9 2.3 772
2002 180 24 2.7 1.1 3.2 928
2003E 217 36 3.6 1.4 4.3 1,179
Source: CEIC.
Note: 2003 data are extrapolation of the first nine month data for production and first eight month data for imports.
Is Credit Tightening Real?
The market has questioned the Chinese government抯 resolve to slow credit expansion, believing that either the government has lost control over credit expansion or it doesn抰 mean what it says. Both are wrong, in my view. The four state banks accounted for 71% of the increase in household savings deposits but only 45% of the increase in lending to the non-financial sector between 1Q02 to 2Q03. The current credit boom is dependent on state bank lending to regional and local banks through the interbank market. There are indications that interbank liquidity has dried up, and the local and regional banks are no longer increasing lending given the lack of funds.
In the real economy, signs of credit distress are popping up. There are frequent complaints that the 慺inancing chain?is broken. A large number of companies in China depend on increasing investment to cover cash shortages associated with bad investments in the past, and their survival totally depends on accelerating credit expansion. I expect a large number of companies could be under severe pressure going forward.
Why should the government tighten? China does not suffer from inflation. Labor surplus and a high savings rate imply that China抯 potential growth rate is substantially above 10%. Thus, the current growth rate may not be excessive. However, China抯 financial system has trouble allocating capital effectively. The misallocation tends to escalate when economic growth is rapid. For example, bad debts could be growing faster than GDP in the current environment, which would cancel the benefit of high growth for the country and may lead to a financial crisis. Thus, the rationale for tightening is to keep bad debts from growing faster than GDP.
Lastly, the market also believes that the government is unable to stem strong capital inflows that in turn boost lending. As has been seen in East Asia before, investment booms in the region are usually 慴ubbles?-- when local credit expansion causes an investment bubble, it tends to attract foreign capital. When it cools, foreign capital tends to leave.更多精彩文章及讨论，请光临枫下论坛 rolia.net