China’s growth recovering amid signs of caution

Erik Norland November 23, 2020 08:26

Prior to the pandemic, China’s official data showed many years of stable growth ranging from 6.2% to 7.5% year on year, rarely missing the consensus estimate by more than 0.1%. That is no longer the case. On October 19, investors learned that China’s economy expanded by 4.9% in Q3 2020. Although the number was 0.6% below consensus, it was an improvement on the 3.2% growth in Q2 and -6.8% in Q1. So far this year, overall growth in the world’s second largest economy is just 0.7% versus the same three quarters in 2019, about one-tenth its usual pace of expansion.

Looking past the headline number reveals several important but easily overlooked trends, some of which are encouraging and others not:

-China’s industrial sector is booming, expanding at around 8-9% per year.

-By contrast, overall growth at only 4.9% YoY in Q3 implies that China’s service sector remains stagnant.

-Debt levels are soaring. So far in 2020, household debt as a percentage of GDP has risen from 55.8% to 61.4%; non-financial corporate debt has increased from 150.3% to 163.4%, and public sector debt has risen from 38.1% to 44.4%. China’s overall level of leverage has risen from 244.3% to 269.2% according to China’s National Bureau of Statistics and the People’s Bank of China.

-China’s imports are strong, but exports are weakening.

Overall, the GDP numbers, taken in the context of the other data, indicate that China, like much of the world, is experiencing a K-shaped recovery - where one branch ascends while the other descends. In China, as elsewhere in the world, the ascending branch includes those who can telecommute to work. Additionally, China’s industrial sector, perhaps more than anywhere else, is moving upward at about the same pace as before.

The descending part of the K includes just about everything else: exports, employees who must show up to work in person, notably in the service sector, and the country’s large population of domestic migrant workers. Overall, Q3 GDP paints a picture of a service economy that is not fully back to normal.

The debt portion of the picture is also troubling. In 2009, when debt levels were much lower (140% of GDP), China engineered an economic boom by encouraging businesses to invest in capital projects, taking on large amounts of debt in the process. This time around, the reason for the rise in debt is less clear. The People’s Bank of China (PBoC) has eased lending standards slightly but has done little in the way of lowering interest rates. Moreover, China’s fiscal stimulus is much less robust than elsewhere in the world. One reason why debt could be increasing as a ratio of GDP is because the denominator has stopped expanding rather than the numerator expanding unusually fast. This is to say that, unlike in 2009 during which debt levels soared to ignite growth, debt is now growing at a rather ordinary pace but ratios are expanding because GDP growth has stalled.

Overall, this paints a worrisome picture for the Chinese economy. With the pandemic’s resurgence in Europe and North America, there is every reason to think that export demand will remain soft for at least another six months, if not longer. Moreover, China’s domestic growth is uneven and has been fueled by rising levels of debt. Yet, global markets don’t seem overly concerned. Perhaps this is because commodity prices have shown a strong correlation with China’s industrial sector.

For the moment, the Chinese currency has been doing well versus the U.S. dollar and most other emerging market currencies. This may reflect China reopening its economy sooner than most other nations as well as the continuing economic distress felt in many countries. That said, the yuan’s continued strength may depend on the ability of China to keep growing despite weak external demand, a still impaired domestic services sector, and soaring debt ratios. Moreover, if history is any guide, any slowdown in China’s economy could also be bearish for commodity prices and send investors fleeing to the U.S. dollar. By contrast, continued economic growth in China might boost commodity prices and foreign currencies as it often has in the past.

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Erik Norland

Senior Economist, CME Group