The official Chinese GDP data show economic growth of 8.1% in the year to end March, as always a little above the recently-reduced official target of 7.5%. There is though a considerable degree of scepticism over this number (in 2007, the GDP data series were described as “for reference only” by Li Keqiang, who becomes Prime Minister in November) as other data series are much weaker. Power output (a data series likely to be accurately measured and very significant in a manufacturing-based economy) rose by only 0.7% over the same period, car retailers are reporting a huge build-up in inventories indicating a fall in consumer confidence, and sales of bulldozers are down by 51% compared with a year ago which indicates weakness in construction. These are worrying figures.
In the very worst of the global economic crisis in 2008/09, China embarked on a staggeringly large investment and infrastructure spending programme in a bid to maintain demand in the economy in 2009 and 2010 whilst they hoped that the rest of the world would sort out their banking crises and associated problems. They were hoping that by the time their own stimulus programme had run its course, the rest of the global economy would have regained its poise and would once again provide the strong consumer demand for Chinese exports. With the US also spending heavily, the world did come out of recession in 2009, and 2010 was also a reasonable year. However Western consumer confidence has not recovered and consumer spending has not returned to make the recovery self-sustaining – and the eurozone’s problems have only made things worse. So the hoped-for recovery in Western demand for Chinese exports has not occurred.
Worse still for the Chinese, the enormous stimulus they delivered has had two serious negative consequences. First was a house price boom in the major cities of China, as the extra spending engendered confidence that Chinese growth would continue to be strong, interest rates were held at low levels and banks were strongly encouraged to lend. In 2011 the authorities became concerned about this and sought ways to reduce the flow of credit for speculative house purchases. Secondly, the infrastructure projects that were built were brought forward from plans for several years hence, and so there are now many entire “ghost” towns built with roads, houses, and shops where nobody lives or works – the infrastructure of China is now years ahead of its current stage of economic development and the demand for that infrastructure. In economic terms the returns from much of the investment boom China undertook have been very low or possibly zero.
China’s economy is now hugely imbalanced with consumer spending just 35% of the economy. Contrast this with the UK and US where consumer spending represents nearly 70% of the economy. If China’s growth story is to be sustained it will need to produce its own consumer demand rather than rely on the Western consumer, and a major rebalancing between investment spending and consumer spending is required. Wages have been growing very quickly, but the Chinese love to save and encouraging them to spend has so far proved difficult. Ironically, whilst the West’s problems are an unaffordable welfare state system and a crumbling infrastructure, China currently has too much infrastructure and not enough of a welfare state. The cost of healthcare in China is very high and pension provision is poor – a stronger safety net might encourage Chinese workers to hold lower savings and go on a mini-consumption boom.
China’s economy is slowing more dramatically than the official data show; commentators have been assuming that in this situation, further economic stimulus would be the policy response. Such a stimulus should not however be a repeat of the government-directed investment spending. Instead to be effective, more subtle policies aimed at boosting consumption are required. Until then, whilst the world watches the Eurozone fall apart they may be missing the problems that are emerging in China. Chinese and Asian equities are the preferred asset class over the next decade, and long term investors should be seeking a heavy exposure in their portfolios. Over the next few months however, there remains scope for investors to be disappointed with Chinese economic developments, and a better buying opportunity is likely to emerge.