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Sinology
a We need to accept and
understand that the
necessary restructuring
and rebalancing of China’s
economy does mean that
almost every aspect of the
economy will continue to
grow at a gradually slower
year-on-year pace for the
foreseeable future.
a Party leaders do not
appear to be too worried,
and they have refrained
from opening their wallets
for a significant stimulus.
a Investors should keep
the slower growth rates
in context. Many parts
of the economy are
clearly still doing well,
with manufacturing
wages rising 5% to 8%,
income rising 8% and the
number of new business
registrations up 38% in
1Q. Understanding why
China is slowing, and the
long-term benefits of the
restructuring policies that
are contributing to that
slowdown, is important
to understanding China’s
impact on the global
economy, and on an
investor’s portfolio.
ANDY ROTHMAN lived and
worked in China for more
than 20 years, analyzing
the country’s economic and
political environment, before
joining Matthews Asia in 2014.
As Investment Strategist, he
has a leading role in shaping
and presenting the firm’s
thoughts on how China should
be viewed at the country,
regional and global level.
by Andy Rothman
April 16, 2015
IRRATIONAL EXPECTATIONS
Do we have irrational expectations for the Chinese economy? On the one
hand, we asked China to restructure and rebalance its economy, and it
has delivered. It shrunk its state sector, and privately owned firms now
account for more than 80% of employment and almost all new job creation.
Almost all prices are set by the market. Investment growth is slowing and
consumption is now the engine of economic expansion. China’s service
sector is now larger than its manufacturing and construction sectors.
But at the same time, we are freaking out because a natural consequence
of this restructuring is gradually slowing economic growth. How, we ask,
can China survive with only 7% GDP growth? Let’s take a look at just how
terrible China’s first quarter macroeconomic performance really was.
The World’s Best Consumption Story
A very weak industrial sector was balanced by strong consumption and
service sector activity, fueled by healthy income growth.
Inflation-adjusted (real) income rose by 8.1% year-on-year (YoY) during
the first quarter, down slightly from 8.6% during the first quarter of 2014.
Income for migrant workers, who move from the countryside to staff the
nation’s factories and construction sites, rose 11.9%, up from 10.1% a year
ago, reflecting a tight labor market.
Strong wage growth and positive consumer sentiment led real retail sales
to rise 10.8% in the first three months of the year, compared to growth
rates of 10.9% last year as well as in 2013. In March, sales for cosmetics rose
10% and furniture sales were up 20%. In the first quarter, movie box office
receipts hit a record US$1.5 billion, up almost 40% YoY. Online retail sales
rose 41%.
Figure 1. REAL GROWTH RATE OF RETAIL SALES
Year-on-Year
16%
14%
12%
10%
8%
6%
4%
2%
0%
Jan-10
Source: CEIC
Sep-10
Jun-11
Mar-12
Dec-12
Sep-13
Jun-14
Mar-15
Industrial value-added output rose by only 6.4% in 1Q15, down from
8.7% a year earlier. But this was balanced by stronger growth in the valueadded production of the *tertiary sector—including services, wholesale and
retail trade, as well as the financial sector and real estate, which rose 7.9%,
marginally faster than a year ago. The tertiary part of the economy continues
to be larger and contribute more to economic growth than the secondary part,
which includes manufacturing and construction. Rebalancing at work.
*Industries defined as:
Primary industry refers to
agriculture, forestry, animal
husbandry and fishery and services
in support of these industries
Secondary industry refers
to mining and quarrying,
manufacturing, production and
supply of electricity, water and
gas, and construction
Tertiary industry refers to all
other economic activities not
included in the primary or
secondary industries, including
real estate, finance, wholesale and
retail, transportation and other
service industries
Figure 2. SERVICES MORE IMPORTANT THAN MANUFACTURING AND CONSTRUCTION
Share of GDP
60%
50%
40%
30%
20%
10%
0%
1952
Primary industry
1960
1965
1970
Secondary industry
1975
1980
1985
1990
1995
2000
2005
2010
1Q15
Tertiary industry
Source: CEIC
Some parts of the economy have suffered more from these big structural shifts.
Value-added output of the mining industry, for example, rose by only 1.4%
last month, while the value-added of manufacturing of computer and telecom
equipment rose 12.3%. As a result, industrial value-added fell 3.2% in the
northeastern region, home to a large share of construction-related factories and
resources extraction, while the rest of the country saw increases of 6% or more.
Figure 3. 2014 GDP GROWTH RATE BY PROVINCE
Below 7%
7–8%
Above 8%
Source: CEIC
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Property Showing Signs of Stabilizing
Even though the government only removed some barriers to new home purchases
(reducing the minimum cash down payment to 40%, from 70%, for upgraders)
at the end of last month, the residential market showed signs of stabilizing. New
home sales fell only 0.9% YoY by volume, after declining 17.8% during the first
two months of the year. It is also positive that developers have been responding
to weaker sales and mounting inventory by cutting housing starts 20% YoY. As
we’ve explained in past issues of Sinology, China’s housing market is past its peak
and is very soft, but we believe a collapse is highly unlikely.
Trade Softer, but Also Far From Collapse
You’ve probably read dire headlines about weak China trade numbers for
March, but the story is more nuanced.
China’s exports fell 15% YoY in U.S. dollar terms last month, compared to an
increase of 48.3% in February. But the huge difference is explained largely
by the lunar New Year effect and monthly volatility. There is no evidence of
collapse in China’s main export markets, nor is there reason to believe that
China’s exports suddenly became far less competitive.
If we look at the first three months of the year, to smooth out the holiday effect,
exports rose by 4.7%, compared to a decline of 3.4% during 1Q14. In 1Q this
year, exports of machinery and electronics products, which account for 58% of
total exports, rose 6.4% YoY.
In 1Q15, exports to the E.U. in U.S. dollar terms rose by only 2.4%, down from
6% a year ago. Exports to Japan fell 11.8%, compared to a rise of 6.7% a year
ago. But exports to the Association of Southeast Asian Nations (ASEAN) rose
20.6% (6.8% a year ago) and shipments to the U.S. rose 11.2%, up from 1.3% a
year ago.
Imports fell 17.6% during 1Q15, compared to an increase of 1.6% in 1Q14. But
much of this was due to sharp falls in commodity prices. For example, during
1Q15, iron ore imports rose 2.4% by volume, and the average price was down 45%.
Crude oil imports rose 7.5% by volume, while the average price was down 47%.
Costs of Restructuring
We need to accept and understand that the necessary restructuring and
rebalancing of China’s economy— along with changes in demographics and
the law of large numbers (two decades of 10% growth)—does mean that almost
every aspect of the economy will continue to grow at a gradually slower YoY
pace for the foreseeable future. (Be prepared for a steady diet of newspaper
articles telling you that the latest quarter’s growth rate was the slowest since the
Tang Dynasty!)
We’d like to ask two questions about this state of affairs. First, how worried is
the Communist Party about the gradual deceleration? Second, how worried
should investors be?
Party leaders do not appear particularly worried. They have refrained from
opening their wallets for a significant stimulus: the growth rates of credit
outstanding and of fiscal spending have continued to decelerate. The Party
has, however, given a modest boost to infrastructure investment, which rose
22.3% in 1Q15, compared to 20.7% last year and 19.7% in 2013. In my view,
this is designed to put a floor under growth by compensating for weak housing
investment, but the Party shows no signs of wanting to reaccelerate GDP
growth back beyond the first quarter’s 7% pace.
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Figure 4. YEAR-ON-YEAR GDP GROWTH RATE
15%
10%
5%
0%
Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
Quarterly GDP
Annual GDP
Source: CEIC
Investors should keep the slower growth rates in context. GDP growth of 7%
is significantly slower than 10%, but because of the larger base, that 7% will
deliver far larger incremental expansion of the economy than 10% a decade ago,
meaning greater opportunity for investors. And, 7% is still 7%! U.S. GDP rose
2.4% last year.
Many parts of the economy are clearly still doing well. While traveling in
China last week, I heard from small private manufacturers who told me they
were planning to raise wages by 5% to 8% this year. Income growth of 8%
compares favorably to 3.2% growth in the U.S., as does Chinese retail sales
growth of 10.8% vs. 3% in the U.S. The number of new business registrations
in China rose 38% in 1Q.
Understanding why China is slowing, and the long-term benefits of the
restructuring policies that are contributing to that slowdown, is important
to understanding China’s impact on the global economy, and on an
investor’s portfolio.
The views and information discussed
in this report are as of the date of
publication, are subject to change
and may not reflect the writer’s
current views. The views expressed
represent an assessment of market
conditions at a specific point in time,
are opinions only and should not be
relied upon as investment advice
regarding a particular investment or
markets in general.
Andy Rothman
Investment Strategist
Matthews Asia
The subject matter contained herein
has been derived from several
sources believed to be reliable and
accurate at the time of compilation.
Matthews International Capital
Management, LLC does not accept
any liability for losses either direct or
consequential caused by the use of
this information.
©2015 Matthews International Capital
Management, LLC
SI015
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