Some Thoughts on Recent Chinese GDP Growth

It’s an understatement to say there has been a lot of dismay at the drop in Chinese year-on-year GDP growth, from 7.7% to 7.5%. Figure 1 below, from the IMF’s Article IV report released on July 17, shows data only through 2013Q1, although the forecast for 2013Q2 looks about right to me.

The blue line year-on-year number for 2013Q2 appears about right (and hence the staff forecast for q/q growth as well, although I can’t find a 2012Q2 q/q estimate on the National Bureau of Statisticswebsite).I think it’s useful to consider the IMF’s assessment before predicting a wholesale collapse in growth.

Despite weak and uncertain global conditions, the economy is expected to grow by around 7.75 percent this year. Although first-quarter GDP data were sluggish, the pace of the economy should pick up moderately in the second half of the year, as the lagged impact of recent strong growth in total social financing (a broad measure of credit) takes hold and in line with a projected mild recovery in the global economy. High-frequency indicators have been mixed recently, with infrastructure spending and retail sales showing more resilience than exports and private nonresidential investment . … Overall, the risks to the near-term outlook have moved more to the downside, as the expected rebound in the second half of the year may not materialize if, for example, external demand for China’s exports remains subdued and/or the weaker activity in recent months spills over into investment and consumer demand going forward. On the upside, credit growth has traditionally been a leading indicator of economic activity, which has also typically seen an upswing following a leadership transition as new local officials ramp up investment spending.

What is important to keep in mind as one considers slower growth is that this has been a long time in coming. The [up to now rhetorical] stress has been on more quality growth, where quality growth means sustainable. In addition, it requires a decreased dependence on fixed investment, which accounts for a very high proportion of GDP — around a half. The incremental contributions to GDP growth are important in this respect.

Figure from IMF Article IV Report on China.

It’s essential for private consumption to rise as a share GDP, reversing the trend in place from 2001 to 2010. This is a recurring theme in Econbrowser [1] [2] (although of course hardly original – seehere and here, for instance; contra here). Otherwise, the rebalancing that has taken place with respect to the external accounts is likely to dissipate.[3]

It’s in this context that one has to understand the recent liberalization of the deposit floor. This in itself has little effect; however to the extent it signals an imminent liberalization of deposit rate ceilings, we might soon see actual moves to ending the financial repression that has limited interest income to households and hence slowed consumption. [4] A more explicit and comprehensive linkage between financial reform and domestic rebalancing away from investment to consumption is provided by Nick Lardy (shorter here).

The question is whether Chinese policymakers can keep their nerves as more news comes in. [5]. It seems the leadership is attempting to stifle panic by committing to a growth floor of 7% (7.5% is the target for 2013) [6].

By the way, none of this is to deny the clear hazards entailed in the process of liberalization, necessary as it is. Financial liberalization – in developing and advanced countries alike – can go terribly wrong, but that is not a reason to stop. As Jun Ma and Michael Spencer note (“Addressing the China Bears,” DB Global Economic Perspsectives [not online]:

… finance has become more complex in recent years, in ways that echo developments in developed market economies prior to 2008. Wealth management products are deposit substitutes created to circumvent restrictions on deposit rates. The funds so raised are invested in assets that are not simply loans, but may be portfolios of loans, or bonds, or properties or other instruments. The lack of transparency is troubling. The likelihood that intermediaries hold less capital against these assets and almost certainly less liquidity makes the system inherently less stable. By all appearances, the large banks that dominate the financial system are much less exposed and the risks may be concentrated in very small, systemically less important institutions.

But as with the [Global Financial Crisis], complexity of finance itself is a source of risk. [Wealth Management Products] in China look like ‘mini-bonds’ in Hong Kong – retail instruments that are inherently riskier than deposits but sold to investors who may not appreciate the difference. ‘Informal securitization’ is an oxymoron but much of the ‘off-balance sheet’ activity appears to be just that. What is needed is regulation, supervision and transparency. …

The longer interest rate liberalization is put off, the harder it will to manage a successful move to a more price-oriented financial market.

The entire Article IV report is required reading, if only because of all the statistics reported in the document. Also, more from The Economist.

This piece is cross-posted from Econbrowser with permission.