Chinese Economy Likely to Decelerate Further in the Fourth Quarter, Albeit Moderately

China grew at 7% year-on-year in the first and the second quarter and 6.9% year-on-year in the third quarter of 2015.  This is its weakest quarterly economic performance since first quarter of 2009 according to official data, growth is likely to decelerate further – albeit moderately – in the fourth quarter (i.e. GDP growth will probably be a bit lower than 6.9% year-on-year in the fourth quarter).  Consequently, annual GDP growth will be lower than the official target of 7% in 2015.

China grew at 7% year-on-year in the first and the second quarter and 6.9% year-on-year in the third quarter of 2015.  This is its weakest quarterly economic performance since first quarter of 2009 according to official data, growth is likely to decelerate further – albeit moderately – in the fourth quarter (i.e. GDP growth will probably be a bit lower than 6.9% year-on-year in the fourth quarter).  Consequently, annual GDP growth will be lower than the official target of 7% in 2015.

However, there has been continued expansion of the services sector (as reflected in official Non-Manufacturing PMI readings remaining above the 50 mark) in the January-November period.

Stimulus measures are supporting the slowing economy.  There has been resilient consumer spending (as reflected in rising retail sales in the July – November period) and increasing car sales in October and November (thanks to the tax break).

Further, an uptick in industrial production in November and substantial ongoing monetary and fiscal stimulus to shore up the economy are going to prevent a marked fall in growth or a sharp slowdown in China (as feared by many) in the fourth quarter.

Having stated the above it must be noted that growth will probably slowdown moderately in the fourth quarter.  Investment and exports account for around 46% and over 25% of GDP respectively in China.

Marked deceleration in both key drivers of the Chinese economy this year and a rise in consumer spending is not sufficient to compensate for the weakness in these two key drivers.  These, coupled with other factors such as downturn in the real estate sector and gargantuan debt overload at around 250% of GDP etc., are putting substantial downward pressure on growth.  This is happening despite substantial monetary and fiscal stimulus administered to this US$10 trillion economy.

Key economic indicators (11) suggest moderate deceleration in growth in the fourth quarter 

1. Official PMI Manufacturing: the manufacturing sector contracted more than expected in November, after an unexpected contraction in October; according to data from National Bureau of Statistics of China, Manufacturing PMI – an indicator of Chinese factory activity – stood at 49.6 in November (the lowest PMI reading in more than three years) compared with 49.8 in the preceding month.

A reading above 50 denotes expansion in activity and below 50 denotes contraction. Further, manufacturing activity has contracted for four consecutive months (i.e. the Manufacturing PMI reading has been below 50 for four consecutive months) – suggesting that the Chinese economy faces a slowdown at the end of the year.

A slowdown in external demand and a relatively strong currency (yuan) continue to weigh on the Chinese manufacturing sector and persistent weakness in this export reliant sector may compel China to further devalue its currency in the near future.

2. Electricity Generation: according to data from National Bureau of Statistics of China, electricity generation, an important indicator of production activity and economic growth and a barometer for the broader economy, returned back to growth in November (as factory output rebounded in November in China).

This after having declined year-on-year for two consecutive months (which reflects a slowdown in industrial demand); electricity generation grew by a paltry 0.1% year-on-year in November (in other words, electricity generation is barely growing – which possibly suggests deeper deceleration in economic activity than what is being officially reported) after having declined year-on-year 3.2% and 3.1% in October and September respectively.

Next, for the first 11 months of this year, electricity generation grew by just 0.1% year-on-year, following 0.1% year-on-year contraction in the same in the first 10 months of this year. Essentially, anemic growth in electricity generation in November, after having declined year-on-year for two consecutive months and highly disappointing growth data on the same for 2015, seems to suggest that China may have entered a new phase of slower economic growth.

Further, even though industrial production rebounded year-on-year in November as per official data, growth in the same has been weak throughout this year. Consequently, a meager year-on-year rise in electricity generation in November should not be regarded as any kind of significant shift from the persistent weakness demonstrated in the same throughout this year.                      

3. Fixed Investment: this key driver of the Chinese economy is growing more slowly; according to data from the National Statistics Bureau of China. fixed investment grew 10.2% year-on-year in the first 11 months of 2015 (unchanged from the 10.2% year-on-year increase in the first 10 months of 2015 and considerably slower than the 15.8% year-on-year growth in the same in the first 11 months of 2014).

In comparison, year-on-year, fixed investment grew (at a higher rate) by 11.2%, 10.9% and 10.3% in the first seven, eight and nine months of 2015 respectively. Slowdown in growth of fixed investment is reflective of overcapacity in real estate and industrial sectors and is acting as a drag on growth.

4. Producer Price inflation: China is facing deflationary pressure: according to data from the National Statistics Bureau of China, the producer price index fell 5.9% year-on-year in November (unchanged from October) – the 45th consecutive month of year-on-year decline in this gauge of producer inflation. 

Falling prices are discouraging production and investments and the brunt of the slowdown is falling on the investment and manufacturing sectors. Further, steeply declining PPI underscores persistent weakness in the Chinese economy and may put pressure on the Chinese government to let the yuan devalue further – which might ease deflationary pressures.

Moreover, deepening factory deflation has pushed real interest rates higher at a time when the industrial sector is confronted with excess capacity and deficiency of demand. Steep and persistent PPI deflation indicates that more monetary stimulus needs to be administered to the economy. The key factors that seem to be responsible for continued and steep decline in PPI are subdued domestic demand and falling commodity prices.

5. CPI Inflation: persistently weak consumer prices (i.e. relatively low inflation) in China point to sluggishness of domestic demand and underscores the gargantuan challenge for the government to boost an economy that is weighed down by debt and excess capacity.

According to data from National Bureau of Statistics of China, inflation on the CPI measure edged up 1.5% year-on-year in November – due to rising prices of food and services – after decelerating in October (1.3% year-on-year). Yet, it might be noted that inflation in November was lower than in the July-September period; inflation rose 1.6%, 2.0% and 1.6% year-on-year in July, August and September respectively (and year-on-year inflation for the January-November period was only 1.4% according to official data). 

Further, it might be noted that inflation on the CPI measure has been below 2% for all of 2015, except for August (where it was at 2%) and is well below the government’s annual CPI target for 2015 of about 3%.

The rise in CPI inflation in November, though eases concerns about deflation and suggests that the six interest rate cuts by the central bank since November 2014 and ongoing fiscal stimulus to boost domestic demand is having some positive effect, yet there does not seem to be an emphatic sign of better or higher domestic demand.

Further, though rise in inflation seems to suggest that the Chinese economy is somewhat stabilizing (i. e. where growth is not falling rapidly or plunging), yet inflation remains below the July-September period – which possibly reflects that growth will moderately slightly in the fourth quarter, when compared to the third quarter.

6. Real Estate Sector: real estate investment, a key driver of the Chinese economy, slowed further in the first 11 months (January-November) of 2015.  This according to data from the National Statistics Bureau of China, real estate investment grew by just 1.3% year-on-year in the first 11 months of 2015, when compared to 2% year-on-year growth in the first ten months of 2015 (January-October) and is the slowest rate of growth in real estate investment in China since the global financial crisis.

For a perspective, real estate investment grew by 2.6% year-on-year in the first nine months of 2015 and has slowed down continually in 2015. Slowing real investment growth will hinder economic recovery in the fourth quarter. The real estate sector accounts for around 15% of China’s GDP and the cooling of this sector has weighted heavily on the Chinese economy over the past year. Any slowdown in this sector has widespread implications for the overall economy.

7. Railway Freight Volume: according to data from China Railway Corp (CRC), railway freight declined 14.99% year-on-year in November (relatively less than October). This year-on-year decline in railway freight volume follows a marked 16.3% year-on-year decline in the same in October (according to data from National Bureau of Statistics of China i.e. official data), compared to decline of 15.6% and 15.3% in September and August respectively.

Further, railway freight volume has witnessed continuous decline in the first 11 months of  2015 – which is reflective of falling demand for commodities, weakness in demand for industrial production (due to prevalence of excess capacity) and the downward pressure that is weighing on the Chinese economy. 

8. New Loans issued by Chinese banks: though new loans issued by Chinese banks rose significantly and more than expected in November – possibly reflecting that the Chinese economy is stabilizing, yet, this positive bit of economic data needs to be kept in perspective.  According to data from People’s Bank of China, new loans issued by Chinese banks rose to 708.9 billion yuan in November, up from 513.6 billion yuan worth of new loans issued in October.

However, two points need noting:

* first, new loans issued were down sharply in October, when compared to 1.05 trillion yuan worth of new loans issued in September

* second, and more importantly, while new loans issued rose more than expected and significantly in November, yet they were lower than new loans issued in each month of the third quarter i.e. July (1.48 trillion yuan – a six year high), August (809.6 billion yuan) and September (1.05 trillion yuan) – as per data from the People’s Bank of China.

This possibly implies that compared to the July-September period, credit demand has softened in the fourth quarter at a time when non-performing assets are on the rise, there is excess capacity in various sectors of the economy, firms are reluctant to invest and the economy is mired in debt.

In essence, though the Chinese economy seems to be stabilizing i.e. not falling off a cliff or witnessing a plunge in growth, yet compared to the previous quarter it seems to be decelerating moderately in the fourth quarter.

Next, though expansion of credit is likely to provide some support to economic activity in China in the coming months, yet boosting faltering growth through such expansion has its limitations in the Chinese context – due to existence of excessive leverage.

Further, it raises concerns about a further rise in non-performing assets, given that growth in 2016 and beyond is likely to settle to a ‘new normal’ of 6.3%-6.5% according to various estimates, as the Chinese economy undergoes a challenging transformation from an investment and export oriented growth model, to a services and consumption led growth model. 

9. Foreign Exchange Reserves: according to data from the People’s Bank of China, foreign exchange reserves fell substantially (more than US$87 billion) in November to US$3.438 trillion (the lowest since February 2013 (US$3.395 trillion)), this after rising slightly in October to US$3.525 trillion from US$3.514 trillion in September.

It suggests that the larger than expected rise in capital outflows from China took place in November due to increased probability of a rise in interest rates in the US (that actually rose on December 16th for the first time since 2008)- which led to increased expectations of higher depreciation of the yuan – and heightened concerns about decelerating economic growth.

Further, the fall in foreign exchange reserves in November (though not as dramatic as the decline in foreign reserves in August) was the largest since a record monthly-fall in the same in August.

10. External Trade: exports fell for the fifth consecutive month  and imports dropped for the thirteenth consecutive month in November; according to data from National Bureau of Statistics for China, exports fell more than expected 6.8% year-on-year in November (a marginal improvement  from the previous month – exports declined 6.9% year-on-year in October) – underlining weakness in external demand.

Further, and more importantly, it might be noted that exports fell significantly year-on-year in October and November, when compared to September and August  – where they declined 3.7% and 5.5% respectively. This seems to suggest that external demand is putting more downward pressure on the Chinese economy towards the end of 2015. 

Imports fell 8.7% year-on-year in November (following a very steep 18.8% year-on-year decline in October).

Though imports fell more moderately in November, compared to October, yet this did not really suggest an improvement in domestic demand, as it was largely due to a lower base of comparison.

Essentially, the external sector continues to be a drag on growth in the fourth quarter. Slowing down of the global economy and the US and the Eurozone (China’s two main export markets) failing to gain sufficient economic momentum has led to a plunge in Chinese exports in recent months. As far as trade surplus is concerned, the same stood at US$54.1billion in November, down from US$61.6 billion in October.

11. Coal Production: according to the National Bureau of Statistics of China, coal production was down 2.7% year-on-year in November. Further, coal production, according to them, was down 3.7% year-on-year in the first 11 months of 2015 (January-November). Noted that coal provides nearly two-thirds of China’s primary energy and decelerating coal production is suggestive of oversupply, weak demand and slower growth.