China Beige Book Report Says Economy Not Collapsing

September 20, 2015 Updated: December 11, 2015

The Chinese economy has recently fallen out of favor with analysts and investors. Asia’s richest man Li Ka-shing has sold most of his assets in the country and some researchers think the GDP could crash by as much as 20 percent over the next five years.

Because of the uncertainty about growth and financial conditions in the world’s second largest economy—after all, most observers live abroad—it’s good to have someone who comes up with empiric evidence to tell us what’s really happening on the ground.    

Leland Miller of the China Beige Book (CBB) collects data from thousands of Chinese firms every quarter including some in-depth interviews with local executives. Although the CBB does not give definitive growth numbers, the message about the third quarter of 2015 is this: It ain’t pretty but we are far from a total collapse.

“What’s most remarkable is how truly unremarkable the quarter was,” the CBB Q3 2015 report states.   

According to CBB, the revenues of the firms questioned (the best proxy for GDP) was a bit weaker than during Q2, but better than Q1 and roughly stable over the year. “Those touting China’s sudden fragility are either exaggerating current problems or have entirely missed the slowdown of the past several years,” states the report. CBB had first noted a slow-down in economic activity in 2012.

In China’s maturing economy, not only is manufacturing no longer the bellwether of the overall economy, but exports are no longer the bellwether of the manufacturing sector.
— China Beige Book

Manufacturing Down, Services Up

One sector that did feel the pinch was manufacturing. Only 48 percent of firms reported a ramp up in production, which was worse reading than during the last quarter and the quarter one year ago. Eighteen percent of the polled firms reported a decline in production, 5 percentage points higher than last quarter.

The service sector on the other hand did relatively better: Revenues were up for 59 percent of firms (6 percentage points more than last quarter) and only 14 percent reported declines. The biggest winner in the sector was media (81 percent of firms reporting increases).

CBB also pointed out that deflation rumors in China are overdone. “For now, the consumer price index is being driven by food, not wages, while the producer price index is being driven by imported commodities, not domestic oversupply,” states the report.

As a result, profit growth improved over the last quarter, with 47 percent of firms reporting an increase in margins. Wages for example, a key factor determining company profits only expanded at 45 percent of firms (47 percent last year). Input costs like raw materials increased for 44 percent of firms (49 percent last year). 

No Demand for Investment

Capital expenditure (the biggest growth contributor for the Chinese GDP) has also been relatively stable, but not really buoyant either. Forty-eight percent of firms reported increases in spending (3 percentage points more than last quarter) and only 11 percent reported a decrease.

CBB confirms, however, that real estate is still in a slump (only 43 percent of companies reported increases in revenues) and that the credit transmission mechanism is broken. This means interest rate cuts will do little to stimulate the economy. 

“Q3 bond yields are more than 1 percent below Q4 2014—and so are bank rates.  Non-bank (‘shadow’) interest rate charges have dropped more than 2 percent in six months. Yet, the economy has not noticeably responded, casting doubt on the idea that another 1 percent can effectively move the needle,” the report states.

The CBB asks the firms and banks polled what rates they pay and charge and therefore has a very accurate reading on costs of capital. The low rates (average for new loans was 6.73 percent) mean there is little demand for capital, as firms don’t see viable projects in the economy.

The fact that only 19 percent of companies polled took out loans this quarter supports the narrative of excess production capacity and little rationale for expansion, also reflected in the stale capex spending numbers. 

So while the People’s Bank of China is pumping in liquidity domestically, there is little demand for it by Chinese companies or international investors—in fact they are pulling money out. In simple supply and demand economic theory this means: A high supply of capital and little demand for it means a lower price (the interest rate), and a lower exchange rate.

CBB also does not think China is devaluing the currency to push exports, where only 34 percent of firms reported an increase in orders. 

“Worsening domestic orders for factory goods was a more important factor in the manufacturing slowdown than were export orders. In China’s maturing economy, not only is manufacturing no longer the bellwether of the overall economy, but exports are no longer the bellwether of the manufacturing sector.” 

Other Notable Findings

  • Manufacturing companies are relatively pessimistic for the future: Only 58 percent of firms see better revenues in two quarters (63 last year)
  • 66 percent of services companies think revenues will increase over the next two quarters (67 percent last year)
  • Despite the price declines in shipping rates, 51 percent of shipping firms reported an increase in revenue, but only 36 percent plan on increasing capex.
  • Residential real estate construction remains in dire straits with only 28 percent of firms reporting an increase in profits and 34 percent reporting a decrease.
  • Average interest rate on non-bank loans fell 0.52 percent over the year to 7.16 percent.
  • The average bond yield fell 0.15 percent to 7.29 percent over the last quarter.