Tuesday, November 5, 2013

What Li Keqiang's 7.2% growth stall speed means

Chinese premier Li Keqiang recently delivered a good news/bad news message for investors by outlining his "stall speed" for China's GDP growth rate:
In one of the few occasions when a top official has specified the minimum level of growth needed for employment, Li said calculations show China's economy must grow 7.2 percent annually to create 10 million jobs a year.

That would cap the urban unemployment rate at around 4 percent, he said.

"We want to stabilize economic growth because we need to guarantee employment essentially," Li was quoted by the Workers' Daily as saying on Monday. His remarks were made at a union meeting two weeks ago but were only published in full this week, just days before a pivotal Communist Party plenum to set policy opens.
At the same time, he paid lip service to the idea of reining in credit growth in order to control inflation:
Yet even as authorities keep an eye on growth, Li sounded a warning on easy credit supply, which he said had topped 100 trillion yuan ($16.4 trillion) in the world's second-biggest economy.

"Our outstanding M2 money supply has at the end of March exceeded 100 trillion yuan, and that is already twice the size of our gross domestic product (GDP)," Li was quoting as saying.

What happens in the next slowdown?
We know from previous statements that China wants to re-focus its growth from an infrastructure and export led model to one based on the Chinese consumer. What was left unsaid in Li Keqiang's statement is what the authorities would do if growth were to slow again. Would they blink yet one more time, as they seemed to do in this last round of growth slowdown, and try to grow the economy using the same tools and stimulate infrastructure growth while ignoring its longer term goal of re-focusing its sources of growth?

Infrastructure spending as a way of stimulating economic growth is facing a problem of reduced efficiency. Richard Iley of BNP Paribas (via ZH) showed that China's ICOR (incremental capital output ratio), which measures how much units of capital expenditure is needed to get 1 unit of GDP growth, has been rising indicating the law of diminishing returns is coming into play.

If the Chinese authorities try to follow the same path to stimulate the economy in the event of a growth slowdown, then they risk inflating a property bubble with the use of a tool that is getting less and less effective.

Risking a financial crisis
We have no idea of what kinds of shocks could cause a growth slowdown in China, but one example might come from the knock-on effect of the Fed's decision to taper. Given the RMB/USD peg, such a decision could export deflation from the US to China. Just consider what happened to emerging market currencies and bond markets in the wake of the Fed's May whisper of a taper and subsequent reversal in September. A disorderly unwind of the leverage built up in the China's property market has the potential to morph into a global financial crisis (see The stakes are rising for China's Third Plenary).

In the short term, the Li Keqiang statement to put a floor on the near-term growth outlook is market friendly and bullish. It does, however, run contrary to their stated philosophy of slowing growth by trading off quantity for quality. This latest statement suggests that the glide path is shallower and risks dislocation should China encounter an external growth shock.

Under these circumstances, it would be prudent to pay extra attention to my canaries in the Chinese coalmine.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

Anonymous said...

China keeps on growing and building.. even if it means an empty mall.