Romance of the three quarters
If the recent pattern holds, China’s latest upturn will be short-lived
“THE empire, long divided, must unite; long united, must divide.” This famous opening from “Romance of the Three Kingdoms”, a classic Chinese novel, refers to the inevitable ebb and flow of dynasties over the centuries. The same principle, in less dramatic fashion, applies to the ups and downs of the economy. But in the past couple of years, the rhythm in China has been unusually fast: the economy, stumbling for a few quarters, must strengthen; strengthening for a few quarters, must stumble.
For now, China’s economy appears to be strengthening again. Real growth edged down to 6.7% year on year in the first quarter, but that figure, subject to fiddling by the authorities, is treated with scepticism by analysts. Instead, they pay more attention to a range of indicators that tell a different story. First, nominal growth—to which corporate earnings are more closely tied—jumped to 7.2% year on year, up from 6% in the final quarter of 2015. Second, the revival of the property sector—the most important part of the economy—gathered pace: the prices of new homes increased by 3.1% in March from a year earlier, the fastest growth since mid-2014. Third, industrial output rose by 6.8% year on year in March, compared with a subdued 5.4% average over the previous two months.
All this is far from the double-digit growth that once seemed so effortless in China, but it is nevertheless striking given investors’ gloomy outlook at the start of this year. Then concerns focused on surging capital outflows, the depreciating yuan and a swooning stockmarket. Now, all three are in much better shape. Foreign-exchange reserves increased in March, for the first time in half a year. The yuan has risen by nearly 2% against the dollar over the past three months, and the CSI 300, an index of Chinese blue-chip stocks, has climbed by 7% since the end of January.
Yet anyone counting on a sustained upturn in the economy would do well to examine the pattern of the past few years. Since early 2012 Chinese growth has been trending downward despite a rapid sequence of ups and downs (see chart). The force behind these fluctuations is on-again-off-again policy support from the government. Determined to keep the economy growing in line with its annual GDP targets, officials have turned to fiscal and monetary stimulus when growth has faltered. Wary of overdoing it, they have pulled back when the economy has picked up.
That might seem to be a feat of fearsomely effective central planning, but, worryingly, each leg-up in the mini-cycle has required a bigger push. The current rebound follows a boom in lending as well as a series of policy incentives that have fuelled a mammoth property rally in the biggest cities. Total new credit rose by 42% in the first quarter compared with a year earlier, the biggest increase in three years. New home prices in Shenzhen, a southern metropolis, soared by 62.5% year on year in March, while those in Shanghai rose 30.5%. When growth flags again, as many expect will happen later this year, the government will have less scope to boost it without raising an already towering debt load.
In the meantime, regulators are trying to undo some of the excesses. They have started to crack down on leverage in the bond market, one of the main channels for new financing in recent months.
Officials in big cities have also made it harder for speculators to buy homes. But appetite for the tougher reforms needed to energise China’s economy in the long term—deleveraging the financial system, breaking up state-owned monopolies and eliminating excess capacity in industry—is still wanting. Shen Jianguang, an economist with Mizuho Securities, believes the government will focus on reforms that support growth, such as providing more financing for business startups. It is reluctant to pursue the more difficult reforms, for fear of undermining growth. That means the next downshift in the mini-cycle is, like the current upturn, only likely to go so far.
Some factors are beyond China’s control, however. A big question stemming from its rebound is how that will influence monetary policy in America. The Federal Reserve has refrained from increasing interest rates after an initial rise in December, with Janet Yellen, the Fed’s chair, highlighting risks from China as a prime reason for caution. Now that China is faring better, the path to a second rate increase in America ought to be clearer. But that might lead the dollar to rise and place renewed pressure on the yuan, which would risk stoking capital outflows and, in turn, fresh concerns about the health of the Chinese economy. If it all sounds a bit dreary, one should at least be grateful that the mini-cycle features none of the death and carnage so prominent in “Romance of the Three Kingdoms”.