China’s second quarter gross domestic product data met the official target of 7.5 percent but there were few positive data points and economists have again cut their forecasts for 2013 and 2014 growth.
Based on Monday’s release, the rebalancing toward consumption away from investment is not proceeding as planned. As Capital Economics wrote in reaction to the report:
5.9 percentage points (pp) of Q2’s growth came from investment, a massive increase on the 2.3pp contribution in Q1, and the highest since Q2 2010. The contribution from consumption dropped from 4.3pp to 2.5pp. Net exports had a negative contribution for the first time in a year.
We previously argued that there seems to be a seasonal pattern that elevates consumption in Q1. As such, the apparent slowdown in Q2 may not be as dramatic as first appears. The big picture though is that investment, rather than consumption, remains the key driver of grow.
Beijing does not appear to be panicking, perhaps because so far the data shows that the labor market is relatively healthy. The resistance to another round of aggressive stimulus may also be a sign that the conventional wisdom about social unrest if growth dropped below a certain level â€" 8 percent was the number for a while -was incorrect.
At this point whether or not G.D.P. is within a few basis points above or below the expected number probably does not matter, other than for the government’s public relations. How and at what cost China will digest its growing bad debt problem and how much resolve the leadership has for reforms are the key issues.
Last week’s column discussed the 2011 prediction by Li Zuojun, an economist at the Development Research Center of the State Council, that China would face a economic crisis in the summer of 2013. Xia Bin, a colleague of Mr. Li’s, said at a forum over the weekend that the G.D.P. fixation was misplaced and that China was already in a financial crisis:
Arguments about whether China will grow at 7 percent or 7.5 percent are “pointless†because the economy is already in a financial crisis which may only worsen if the government doesn’t address the country’s crippling debt problem…
We need to find ways to let the bubble burst and write off the losses we already have as soon as possible to avoid an even bigger crisis…
Deep adjustment means economic growth slows as costs are paid, it means hard days, it means the bankruptcy of some companies and financial institutions and it means reform.
The message from Beijing continues to be that reform and painful restructuring are coming. After the G.D.P. release, Caijing magazine, one of the best business publications in China, reported that “substantive reforms†are in the works:
“The restart of a new round of economic reforms will have a vital impact on the Chinese economy,†a source close to China’s top policy making agencies told Caijing, referring to a guideline expected to be announced at a plenary meeting of the Central Committee due this fall.
Reforms in areas such as taxation, finance and energy, which are well-prepared, will first kick off, said the source.
This is an interesting leak, perhaps done in an attempt to reassure that reforms are coming and better days are coming, eventually.
Another leak, reported Monday in The South China Morning Post, highlights the difficulty of reform. According to the newspaper, Premier Li Keqiang faced significant opposition to the recently announced plan for a Shanghai free-trade zone:
Financial industry regulators, including the China Banking Regulatory Commission (CBRC) and China Securities Regulatory Commission (CSRC), openly disagreed with Li’s plan to open Shanghai’s financial services sector to foreign investors. Three sources with first-hand knowledge of high-level government meetings told The South China Morning Post that Li lost his temper at one closed-door cabinet session. When told of the continuing opposition to his plans, he slammed his fist on the table in frustration.
The premier pushed the plan through, but much more difficult reforms that affect many more entrenched interests lie ahead.
It is now difficult for even the most bullish of China analysts to argue that the economy is not in very difficult straits that look to persist at least for several quarters. A hopeful argument may be that the almost uniform sense of existing or impending crisis will give Xi Jinping and Li Keqiang the levers they need to push forward the painful reforms.
We will know more by October when the Third Plenum meets. Even if the meeting passes an ambitious set of reforms it will still take several months or longer for those changes to flow through to the real economy, and implementation will likely be very difficult.
For those looking for historical support that the Party can enact another round of deep reforms, I highly recommend “Wealth and Power: China’s Long March to the Twenty-first Century,†an excellent new book from Orville Schell and John Delury. The book, excerpted here, goes a long way to explaining what drives the current leadership, and why betting against their resolve to reform may be risky in the medium to long-term.
But nothing destroys wealth like debt, and until China deals with its credit crisis the road to wealth is going to be very rocky.
