Economy Trended Down in First Three Quarters. Light of Stabilization at the End of Tunnel
Despite the single-month resurgence in economic figures during September, the marginal improvements could not offset the dreadful numbers from the two previous months. Third Quarter figures indicate a further slowdown of the economy. However, with the “counter-cyclical” policy’s support, some sector’s figures such as manufacturing, consumption and investments showed a faint but increasingly clear sign of stabilization. At this point, there are uncertainties from external political and economic situations, but supportive domestic elements and policies also abound and are acting in concert. There is still room for downward trending in the Fourth Quarter economy but the scale could be limited.
Third Quarter GDP growth marked a historical low of 6% on year-on-year basis. As a result, first three quarter GDP growth slipped 0.1 of a percentage point to 6.2%, a 0.5 percentage point drop from the same time last year. Among the “Troika” of growth drivers, consumption and capital investment maintained their pull on GDP growth, contributing 3.8% and 1.2% respectively, in line with the first half of the year. Net export’s contribution to GDP growth shrank 0.1 of a percentage point to 1.2%. Compared to the same period last year, consumption and capital investment posted significant drops of 1.4 and 1.2 percentage points respectively. Recessionary surplus pushed net export up 2.2 percentage points compared to the same period of last year.
Considering the low basis of comparison from Fourth Quarter of last year and the support of many current policies, we are optimistic, and estimate the whole year GDP growth will likely be above 6%. There is little chance the figure will break below 6.
On the industrial production side, the bounce back in mining and manufacturing provided the major support for the growth of September industrial value-added. Between the two, the acceleration of mining production did not come from the demand side. Based on our studies, we tie the growth to advance stocking up by manufacturers in anticipation of production limits in fall and winter, as well as high level of production in September in domestic crude oil sector. As a result of marginally improving trade climate and the Exclusion List from US Trade Representative, part of domestic manufacturing showed signs of recovery. In terms of specific sectors, export-oriented sectors including computer and electronic equipment, specialized equipments, general equipments, electric machinery and apparatus led the manufacturing growth. As a result, first three quarters industrial output grew 5.6% compared to the same period last year, maintaining the same rate as the one from January to August but 0.4 of a
percentage point lower than the first half of the year and 0.8 of a percentage point lower than the same period of last year.
Looking ahead, there is still downward pressure in the industrial sector, which is in a phase between de-stocking and replenishment. However, there is no need to be overly worried, considering the first phase success of the US-China trade talks, the continued counter-cyclical policy support, stabilizing effect of the investments, as well as the individual considerations under the production limit during winter, there is limited negative impact in Fourth Quarter industrial sector. Based on the above, we estimate full year industrial value-added growth to be between 5.4 and 5.5%.
On the fixed asset investment side, we saw a decrease in fixed assets investment but the scale of the decrease is shrinking. Growth in the first three quarters extended the downward trend from the first half of the year and shrank 0.1 of a percentage point to 5.4% when compared with the rate from January to August. It was also a decrease of 0.4 of a percentage point compared to the growth rate in the first half of the year, but was in line with the same period of last year.
Looking ahead, high end manufacturing will have favorable policy support. Local infrastructure spending is recovering and real estate development is expected to be resilient. As a result, Fourth Quarter fixed asset investment will maintain a steady growth pace. However, on a long term basis, the supportive effect of infrastructure and real estate investments to the economy is not sustainable. The former will be limited by the rapidly slipping income from land sales and the decrease in taxes and fees. Even when there is a growth spurt in targeted debt issuance, the tight local fiscal situation will persist. The latter will be bound by the “apartments for living, not for speculation” policy. Even when the de-stocking is complete, it is unlikely that we will see rapid growth in the new round of real estate investment. In the future, investments in manufacturing will be the key. This in turn will be determined by the pace of transition of the domestic economy, the directions of the policies, and the support of the capital markets. Among these, the support from private equity investments are especially important.
On the domestic consumption side, we saw a small recovery in the growth rate in September thanks to the deceleration in the decrease of automobile sales. However, car sales are influenced by the holidays and a low basis of comparison. Actual demand of automobiles from residents is still at a low point. As described in the previous issue, if we ignore the offsetting effect of inflation, Third Quarter consumption’s contribution to GDP growth is further weakening. With the recovery of consumption growth in September, first three quarters’ retail growth maintained the 8.2% rate we saw in the January to August period, but is still 0.2 percentage point lower than the first half of the year.
Overall, the domestic consumption level stays low. As the residents’ disposable income growth slows from quarter to quarter, the recovery in consumption is nowhere in sight. Our forecast is that the low consumption level will extend into the Fourth Quarter. Further studies indicate that the weak resident income growth put a damper on marginal consumption tendency. However, as the offsetting effect of inflation and the implementation of previous consumption policies in the Fourth Quarter, consumption’s drag on GDP growth will be muted and unlikely to show a significant decline.
On the overseas demand side, September saw the export and import trade volume shrank further and on a larger scale. First three quarter export declined 0.1% compared to the same period last year and 0.2 of a percentage point lower than the growth speed in the first half of the year. Import growth slipped 0.8 of a
percentage point, to -5%, compared to the first half of the year. Nevertheless, as the import volume declined at a faster pace than export, recessionary surplus persisted with the Third Quarter surplus growing 118.6 billion US dollars and cumulative January to August surplus totaling 298.4 billion US dollars, a 79.1 billion increase compared to the same period last year. Single month figures worsened. Our studies indicate that aside from fundamental issues such as uncertainties with major global economies, US-China trade friction, and weak domestic demand, the basis for comparison and prices also contributed to the decline in September figures. Specifically, US-China trade friction caused a decline in consumer goods exports which dragged down the September export figure.
In fact, the Phase One success of US-China trade talks merely placed the two sides back to the positions before August. As the talks move toward core demands, the end results are still uncertain. What is clear is that US-China relationship will not be what it was even after the trade war is over. There will be more competition than cooperation between the two, and trade friction has expanded to capital markets, technology, culture, and the political scene.
Boosted by seasonal overseas demands ahead of the holiday season, new export orders PMI rose 1 point to 48.2 compared to last month, but still on the contraction side. Looking ahead, domestic economy might see some recovery from the counter cyclical policy support, but uncertainties in global economy and an increase in systemic risk in Fourth Quarter will limit the recovery in export, reducing the surplus as well as the positive effect of net export on domestic GDP growth.
On the private sector financing side, on-the-book Renminbi loans, off-the-book non-standard debt, and corporate debt are main contributors to September private financing growth. When taken together, the first three quarters saw a). relatively rapid growth of Renminbi loans despite the weakness in corporate medium- and long-term loan growth; b). robust growth in corporate debt, especially in local targeted debt issuance; c). significant improvement in the previously declining off-the-book financing. These reflect the fact that effective demand for financing was suppressed in the backdrop of the US-China trade friction and the low willingness to invest among enterprises. Fourth Quarter credit and financing data could still see a rebound, ensuring a healthy whole-year economic growth figure.
On the exchange rate side, the pressure for the Renminbi to depreciate is expected to further lessen in the Fourth Quarter. First, the fundamental gap between the US and Chinese economies is shrinking. Second, the interest rate spread between US and China’s ten-year national debt stays at the historical high of 150bps. Third, US-China trade talks is progressing positively and market expectation for Renminbi depreciation is muted.
In the face of downward pressure, domestic counter-cyclical policies have been strengthened to target pain points. China maintained its open door policy which is now a basic national strategy, despite the complex external economic and political climate.
For equity investors, there are in fact many challenges, but also unprecedented opportunities. Overall, with the continued progress of counter-cyclical adjustments in China, policies regarding private equity investments are being perfected and supported by the regulatory authorities. Over the long term, equity investments can shrug off the negative effect of the new Guidance of Asset Management. In the short term, equity investors are facing headwinds during its raise, investment, management, and exit during the economic downturn. The rule of the oligarchs persists with the strong staying strong.
Our recommendation is that institutional equity investors pay close attention to local governments’ need for economic transition and upgrade during raises, and maintain communication with core financial institutions such as banks and insurance companies, in anticipation of opportunities as governmental policies come around to a favorable angle. On the investment side, note the directions that policies point to, which include high tech manufacturing, consumption upgrades, import substitution, new energy, and opportunities brought by the aging population. On the exit side, pay attention to the diversifying capital markets in China. In addition, as the bilateral opening up of capital markets pushes ahead, opportunities brought by cross-border investments should not be ignored. We recommend that attention be paid to the financial policy changes in the Guangdong-Hong Kong-Macau Bay area and the opportunities that come with them.
As to potential risks, we advise that the following four issues be closely watched: a) potential flare-up of US-China trade tension; b) continued upward push to CPI by the supply end; c) systemic risk brought by the tightening real estate financing; and d) slowing resident income growth and deteriorating labor market.