China’s GDP growth came in on target in the first quarter. Slumping output in March, a slide into deflation and an expanding credit bubble underline the magnitude of the challenge the economy continues to face. We believe the weeks ahead will see the government intensifying efforts to support growth.
GDP growth came in at 7 percent year on year, down from 7.3 percent in the final quarter of 2014, but in line with Premier Li Keqiang’s target of 7 percent for the year. On a quarter-on-quarter annualized basis, the economy slowed to 5.3 percent growth, down from 6.1 percent.
Alternative measures of growth painted a gloomier picture. Bloomberg’s monthly GDP tracker came in at 6.5 percent year on year in the first quarter. An index composed of electricity, rail freight and bank loans — measures reportedly favored by Li — suggested growth is in the mid-single digits.
March data showed the economy slumping into the end of the quarter. Industrial output, the main monthly measure of growth, came in at 5.6 percent year on year, down from 6.8 percent growth in the first two months of the year. That’s only slightly higher than the 3.8 percent trough for the series at the start of 2009.
Weak output reflected a broad-based slowdown in demand. Fixed asset investment came down to 13.5 percent year-on-year growth in the first three months, down from 13.9 percent in the first two months. Behind that is a continued slowdown in capital spending in the real estate and manufacturing sectors, offset by stronger spending on infrastructure.
The latest signs on the all-important real estate sector point to a continued contraction. Sales volume and the area of new land under construction both continued to fall in the first quarter. Land sales, a crucial source of revenue for local governments, are down 32 percent. Credit data was a little more positive, with the People’s Bank of China reporting that loans to the real estate sector rose 19.4 percent year on year in the first quarter.
Retail sales slowed to 10.2 percent year on year, down from 10.7 percent in the first two months of the year. Sales continue to be impeded by concerns about wage growth and a negative wealth effect from falling property prices. Judging from falling gaming revenue in Macau and jewelry sales in Hong Kong, the crackdown on corruption is also having an impact on spending.
Export data, published earlier in the week, was also gloomy. Taking the first quarter as a whole, exports eked out a meager 5 percent year-on-year increase. That’s a reflection of the blow to competitiveness from a stronger yuan and a lackluster recovery in major trade partners, including recent signs of weakness in the U.S.
Compounding signs of trouble, the GDP deflator shows the economy in deflation for the first time since 2009. Bloomberg calculations put the GDP deflator at minus 1.2 percent in the first quarter, down from 0.9 percent for 2014 as a whole. As the experience in Japan has shown, sustained deflation can result in a downward spiral of delayed purchases, weaker demand and falling growth.
The People’s Bank of China is putting a positive spin on it. Following March’s weak loan growth, PBOC statistician Sheng Songcheng said the data reflected success in cracking down on shadow banking, and that the cost of credit is coming down. The average interest rate on one-year loans is now 6.83 percent, down from 6.95 percent at the end of 2014, he said.
Even so, with real interest rates high and the yuan up in trade-weighted terms, we believe policy remains uncomfortably tight. That suggests an accelerated shift to stimulus is imminent. In the immediate future, that will likely include a further rate cut and reduction in the reserve requirement ratio, continued use of new tools to target cheap credit to priority sectors, and easier conditions for the real estate sector.
The GDP data also provides an opportunity to delve into the structural challenges the economy faces. Top of the list of concerns is excess growth in credit. The challenge here is that, even as credit slows, growth in nominal output is slowing even faster. Outstanding credit rose to 204 percent of GDP in the first quarter, up from 200 percent at the end of 2014, according to Bloomberg calculations.
There was better news on the structure of the economy, which continued to improve. Growth in services held steady at 7.9 percent year on year, outpacing a 6.4 percent expansion in industry. With hairdressers and accountants more labor intensive and less polluting than steel furnaces and cement kilns, a larger role for the services is a positive development. It might also explain the divergence between industrial output and GDP growth.
Bloomberg’s real activity indexes pointed in the same direction. The ‘new economy’ index — which covers growth of high tech manufacturing, private sector firms, services and clean energy — accelerated in the first quarter. The ‘old economy’ index — which covers growth of low value added manufacturing, state owned enterprises, investment and thermal energy — remained in the doldrums.
Wage growth — critical for the shift toward a more consumption-driven economy — stayed solid. Disposable income was up 8.1 percent year on year in real terms, fractionally up from the fourth quarter of 2014. Wages for migrant workers rose a robust 11.9 percent. Consumption likely contributed about 60 percent to first-quarter growth, in line with 2014, according to the National Bureau of Statistics.
The authors of this post are economists from Bloomberg Intelligence.