China's Economy: Recovery Gains Momentum

Investors and economists are arguing about whether the U.S. economy has any "green shoots" signaling a recovery from the financial crisis, but when it comes to China's economy, there's little debate: Upward revisions to gross domestic product growth projections just keep on coming.

The latest revision comes from Frank Gong, JPMorgan Chase's (JPM) chief China economist, who expects the country's economy to grow 7.8% this year, compared with his previous forecast of 7.2% a few months ago. "The economy is doing a lot better than the market expects," says Gong. "The risk is on the upside." His prognosis for next year is even rosier, with an expectation of 9% growth, compared with his earlier forecast of 8.5%. If the rest of the world pulls out of its slump next year, China could even be looking at double-digit growth again, he says.

Many other economists are sounding bullish about China, where GDP growth bottomed out in the first quarter at 6.1%. Last month the World Bank upped its estimate for Chinese economic growth in 2009 to 7.2%, having forecast in March only 6.5% growth. A few days later the Organization for Economic Cooperation & Development weighed in with a prediction of 7.7%, vs. an earlier figure of 6.3%. Credit Suisse (CS) is calling for 8% growth this year and 9% in 2010.

For the moment, China’s exports continue to contract, although at a slower rate. On July 10, Xinhua News Agency reported a 21.4% decline in exports during June from a year earlier, continuing an eight-month slump. However, exports grew 7.5% from May, and some believe things have turned a corner. JPMorgan’s Gong notes that the export component of China’s Purchasing Managers Index in May was above 50 for the first time in a year, signaling an expansion rather than a contraction in new export orders.

What's surprising and encouraging about the strength of China's recovery is that so much of it seems to be fueled by Chinese consumers. To be sure, the $586 billion economic stimulus package unveiled by the government last November has helped prime the pump, as has a nearly $1.3 trillion expansion in credit since the beginning of the year.

Vibrant Local Auto Sales

But there's mounting evidence that China is moving closer to its long-cherished goal of weaning itself off exports through increased local consumption. Take the auto market. At the beginning of the year, China's auto industry was predicting a contraction in vehicle sales owing to an anemic (for China) 6.7% growth last year. Instead, the China Association of Automobile Manufacturers on July 7 reported a huge 17.7% increase in sales, to 6.1 million autos for the first half of the year, and it's predicting this year's sales could top 12 million. For instance, General Motors' (GM) sales through its joint ventures rose 38% in the first half, to 814,442 vehicles.

The main reason auto sales have been unexpectedly strong is because most growth is coming from smaller cities in China's heartland. These cities have been spared the worst of the export slowdown that has battered mainland coastal cities. "Geographically, there is a shift in growth drivers away from the coastal areas of export powerhouse to the inland region," says HSBC China economist Qu Hongbing, who is calling for GDP growth of 7.8% this year and is planning to revise next year's above 9%. "Consumer spending, believe it or not, is holding up better than people expected."

Another development that has taken some by surprise is the speed with which China's real estate sector has recovered, perhaps because so many foreign observers only see the idled cranes in cities such as Shanghai, Guangzhou, and Beijing, big cities that were overbuilt during the property bubble of 2006-07. But a countrywide slump throughout most of the past year has given way to a massive rebound in transactions, thanks to government incentives for first-time buyers and low interest rates. Property sales were up 53% in the first six months from a year earlier, according to a survey commissioned by the statistics bureau and published in the China Information News, while nationwide prices averaged across 70 cities climbed year-on-year in June. This masks the fact that in second= and third-tier cities prices have been strengthening much more.

Investment Enthusiasm

More important, excess housing inventory has been snapped up, encouraging developers to start new projects. Real estate investment increased 10% year-on-year, an important sign of a rebound. In the second half of last year, property investment was nearly zero, while it normally accounts for about 25% of fixed-asset investments in China.

A strong recovery in the stock market has helped buoy optimism, too. The CSI 300 index of China's top companies listed in Shanghai and Shenzhen is up 87% this year. How much longer the rally will last remains to be seen, however. China only resumed initial public offerings this month after a 10-month hiatus, and there are more than 1,000 companies waiting to list their shares. Because Chinese investors tend to dump their current stock holdings to buy into new IPOs, a glut in new issues could drag things down.

But so far there's little sign of that happening. On July 10, Shenzhen-listed A shares in traditional Chinese medicine company Guilin Sanjin Pharmaceutical more than doubled in early trading from their IPO price, as did the shares of industrial cable maker Zhejiang Wanma, which also debuted the same day.

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