China’s ‘real GDP’ headlines tell us little, with quarterly movements sticking very closely to both trend and official expectations. Nominal GDP, however, is accelerating sharply, which suggests:
rising inflationary pressures, denied by CPI but surfacing in PPI, but also;
recovering return on capital, which underpins current profits growth and likely future GDP growth’; but also:
the slowdown in growth of capital stock (down to nominal 8.4% yoy estimated in 2016) is implicated in China now losing market share of NE Asia exports.
the credit squeeze has produced a noticeable recovery in the marginal economic efficiency of finance, but there is a very long way to go before China is weaned off credit-fired growth; and
the improvement in overall allocation of savings is much less convincing than the improvement in bank credit allocation.
In short, the 4Q national accounts do show some progress being made in the structure of China’s growth. But the progress is painfully slow compared to the distance to be travelled, and is already developing unexpected diversions.
China’s quarterly GDP headlines rarely deviate far from the government’s forecast, and the only real interest is the size and direction of the ‘error.’ In today’s case, the 6.8% % growth in 4Q was 0.1pp higher than expected, from which we should take that the economy is performing just a smidgen better than the expected ‘stabilization’ of 6.7%. Look closer, however, and the ‘real’ quarterly gain was exactly in line with the average of the last three years. There have been no significant or sustained variations against that trend now for seven quarters, and no-one is stepping out of line in 4Q.
Nothing destabilizing, then, though the ‘extra’ growth allows one to tighten very slightly the likely range of of monetary and fiscal policy options.
And this general message concurs with the overall tenor of the monthly data in 4Q, which despite December’s numbers weakening slightly, still showed a modest upturn in underlying momentum for both the industrial economy and domestic demand indicators.
Far more interesting, and marginally more plausible, was the result for nominal GDP, which rose 13.3% yoy, the fastest since 4Q11. This took nominal GDP growth for 2016 to 10%, up from 6.4% in 2015 and 8.1% in 2014.
This also suggested a GDP deflator which had accelerated to 6.5% yoy, also the highest since 4Q11, suggesting a far more difficult inflationary environment than is signalled by CPI (2.1% in December), although in the same ballpark as PPI is flashing (5.5% yoy in December).
Nominal GDP Deconstructed
Nominal GDP acceleration is worth deconstructing slightly. The trade surplus for 4Q fell 18.2% yoy in Rmb terms, to Rmb 912.5bn, which was equivalent to 4.3% of 4Q GDP, down from 5.9% in 4Q15. That narrowing of the trade surplus stripped 1.1pps from 4Q nominal GDP growth: excluding that, nominal domestic demand grew by no less than 15.3% yoy. At this point, it becomes interesting to compare that 15.3% yoy domestic demand growth with 4Q’s 11.5% yoy rise in M2 growth, the 13.2% yoy rise in Rmb bank lending growth, and the ‘guesstimated’ 12% rise in total aggregate financing growth.
The 15.3% yoy rise in nominal domestic demand included a sizeable fiscal deficit. We do not yet have the exact figures for December’s deficit (and possibly it may not be released), but I estimate it to have been around Rmb 2.36tr, approximately 10.8% higher than in 4Q15. If one excludes the net public spending from domestic GDP, then private domestic nominal spending rose by 14.8% yoy, the fastest since 1Q12.
This recovery in nominal GDP suggests a broadening improvement in capital allocation with China’s economy. Judging from the slowdown in urban fixed capital spending (8.1% only in 2016, down from 9.9% in 2015 and 15% in 2014), and depreciating all the investment spending counted in the national accounts over a 10yr period, I estimate that nominal growth in China’s capital stock slowed to just 8.4% yoy. This is sharply slower than nominal GDP growth, implying that the asset return on that capital stock is now finally rising. If so, this reverses the continuous decline seen since 2007.
This slowdown in capital stock growth and rise in return on capital has two consequences and a likely implication.
The first consequence is that it underpins and helps explain the recovery in industrial profits seen in 2016: industrial profits for Jan-Nov rose 8.9%, and will probably have risen just under 10% for the year as a whole. This is a recovery from the 1.8% fall in 2015 and 3% growth in 2014.
The second consequence is that the slowing growth in capital stock is also having a negative impact on China’s market share of NE Asia exports. During 2016, China accounted for 59.7% of NE Asia’s exports, down 1.6 percentage points - the first market share loss since 2010 and the worst since 2006. Part of this loss may be explain by a loss of comparative advantage, but the sharp slowdown in relative growth of industrial capacity is also a major contributing/explanatory factor.
If these are the two obvious consequences, the likely implication is more positive: a rise in return on capital will help backstop growth and financial prospects in 2017 and beyond.
Efficiency of finance
Allied to the recovery in return on capital and industrial profits is a now quite visible improvement in the economic efficiency of credit. During 2016, the addition of one extra yuan of bank credit was associated with an increase of 53 fen of GDP, which was the highest since 2014. This measurement probably slightly understates the improvement, since squeezing a higher proportion of total finance into formal bank lending and away from ‘shadow banking arrangements’ was a major preoccupation of regulators throughout the year. If one takes the wider ‘aggregate financing’ total, one finds that one extra yuan of aggregate financing was associated with 38 fen of extra GDP growth, which was the highest since 2Q12.
To state the obvious: despite the improvement seen in 2016, the efficiency of finance remains at historically very low levels, and both imply that any significant sustained deleveraging will be extremely painful in GDP terms. Nevertheless, it is only fair to acknowledge that at the margins, the economic effectiveness of finance did improve in 2016, and continued improving to the end of the year.
Monetary velocity & Liquidity Preference
But how much of this improvement is simply a consequence of a credit squeeze, demanded by the authorities and/or compelled by the drain on banks’ cashflows generated by the exodus of the capital from the Renminbi? Those efficiency of finance ratios concentrate on the impact of the growth in the asset side of banks’ balance sheets, but perhaps a truer measure of the allocation of savings would look rather at the liabilities side of the balance sheet. It is, after all, these savings which are being mobilized more or less efficiently.
Monetary velocity (GDP/M2) reflects this, and although there is enough in 4Q’s GDP growth to generate an small uptick in monetary velocity, there is no convincing inflection point visible yet.
Finally, how is one to interpret the sharp and continuing rise in liquidity preference (M1/M2)? Here are three possible interpretations:
People are keeping proportionately more cash to hand because they feel more inclined to impulse purchases of goods, services, or investments;
People are keeping more cash to hand because a rise in inflationary pressures makes it less attractive to keep money on deposit, where its real value erodes;
People are keeping more cash to hand because they are considering selling Renminbi for dollars.