China: Forget About Rebalancing
Nobody believes the official Chinese economic data, but people still have to use it in their analysis because there aren’t many good alternatives.
The official data for 2016 tells us real estate in China is bubbly, credit is growing by leaps and bounds, manufacturing activity is bouncing back, and State Owned Enterprises (SOEs) are investing like there is no tomorrow, while their private counterparties are slamming their wallets shut.
In the meantime, profits at most companies are hurting. Struggling to repay their massive debts, some of them have even folded and gone out of business.
So if the official data is unreliable, what is really going on? Fortunately, we have the China Beige Book (CBB) to tell us what’s happening on the ground—and this quarter’s findings largely back the official narrative.
On the Ground Data Backs Up Stimulus Theory
CBB collects data from thousands of Chinese firms every quarter including some in-depth interviews with local executives and bankers. Although the CBB does not give definitive growth numbers, it logs how many companies increased their revenues or how many laid off workers, for example.
Most importantly, the CBB report for the third quarter of 2016 backs up the claim the Chinese regime resorted to old-school stimulus to keep employment from collapsing, thus pouring cold water over the hopes of a rebalancing to a consumer and services economy.
“The growth engines this quarter were exclusively ‘old economy’—manufacturing, property, and commodities. The ‘new economy’—services, transportation, and especially retail—saw weaker results,” the reports states.
In sync with the official manufacturing indicators, the China Beige Book reports revenue increases at 53 percent of manufacturing companies, a full 9 percentage points higher than last quarter.
The property sector is red-hot according to official data with double-digit price and sales increases. Accordingly, CBB reports 52 percent of companies increased their revenues, 4 percentage points more than last quarter.
Both manufacturing and property rebounded because of an increase in debt and infrastructure investment, mostly for home mortgages as well as investment by SOEs.
“The number of firms taking loans leapt off the floor we’ve seen for the past three quarters to its highest level in three years,” CBB states.
According to official data, bank loans grew 13 percent in August compared to a year earlier and the CBB reports 27 percent of companies increased their borrowing, a full 10 percentage points more than the quarter before.
“If sales and prices continue to rise in the fourth quarter, it will be due to yet more leveraging,” CBB says about real estate. According to People’s Bank of China (PBOC) data, household loans made up 71 percent of new bank loans in August.
The report also confirms that SOEs invested the most with 60 percent of them increasing their capital expenditure, up 16 percentage points from the second quarter.
“Impatient for stronger growth, Chinese policymakers were likely to shelve their
rebalancing goal, and ‘double-down’ on investment-led growth,” Fathom Consulting stated in a recent report on China. The numbers on the ground confirm this assessment.
Conversely, smaller private companies did not invest much at all. The smallest companies increased investment in 34 percent of the cases, compared to 44 percent the quarter before.
“While we still see bank borrowing … as the most important driver for infrastructure in the near to mid-term, we expect its sustainable growth to hinge upon more private capital involvement,” the investment bank Goldman Sachs writes in a report.
Price to Pay
This centrally planned strategy comes at a price, however. “CBB data show profits and cash flow deteriorated, casting a pall over recorded increases in borrowing and investment,” the report states with only 45 percent of companies reporting an increase in profits, compared to 47 percent last quarter. CBB also points out that cash flow deteriorated across the board, explaining the rise in company defaults this year.
The main reason for this renewed stimulus, according to the CBB, is the Chinese regime’s fear of unemployment, which started to show up in CBB data in the second quarter. The official unemployment rate is infamously unreliable because it has been staying at 4 percent for the last ten years.
So after this quarter’s offensive in investment, 38 percent of companies said they hired more people in the third quarter. “Hiring was again strong and it is fair to say this is the single most important issue for the central government,” CBB states.
But buying a bit of growth and employment with a bit of credit is an old trick? What about the much-touted rebalancing and reform?
“A more service-oriented economy will give rise to higher share of labor income in GDP, but a more redistributive fiscal policy is necessary to bring down income inequality, and provide more equal opportunities to both urban and rural households,” the International Monetary Fund (IMF) wrote in a recent report.
Alas, the CBB data on the ground does not confirm this is happening at all. If anything, the third quarter was a step back.
“Services, transport, and especially retail saw profits hit hard on-quarter,” CBB states. Only 53 percent of services companies reported an increase in earnings, compared to 57 percent in the last quarter.