China economic forecasts: go herbal or Western?

By Wei Gu
May 6, 2009

(Wei Gu is a Reuters columnist. The opinions expressed are her own)

Which would you believe when it comes to diagnosing the health of China’s economy — the pulse-taking of the herbal doctor or the lab tests of Western medicine?

Beijing’s leaders are like the herbal doctors, using creative metrics such as power output and shipping indexes that can give a relatively accurate snapshot of manufacturing activity.

Private-sector economists, by comparison, believe in more mainstream data such as money supply and fixed asset investment even though they might not be completely useful in measuring a transitioning economy such as China.

Going by the latest economic indicators, the pulse shows the body is still listless, while the lab test is showing signs of a recovery to health. The last time this happened to China was in 2001, when the world was about to emerge from a brief recession.

It turns out that — like the debate over Western versus Eastern medicine — both methods have their pros and cons. And their relative advantages may be shifting as China itself changes.

Although very few Chinese leaders have an economics background, they still have a special insight into China’s economy. So, when Premier Wen Jiabao said that a key economic gauge is power consumption, people took notice.

Power output traditionally has shown a strong correlation with business activity as the Chinese economy is one of the most energy dependent in the world.

Its beauty is that it is not distorted by inventories, is difficult to manipulate and is available almost real-time. Chinese banks routinely check the utility bills of their clients to make sure that factories are still busy.

Amid the current economic turbulence, the timeliness of such data has been crucial to Chinese leaders who want to be able to make speedy decisions.

China’s power output in April declined 3.6 percent from a year earlier, marking a continued fall in the country’s consumption of electricity, the official Xinhua news agency said.

The report defied investors’ belief that China’s massive economic stimulus package has led to a sharp rebound for manufacturers as indicated by the bullish reading on the purchasing managers’ index.

But with China moving away from heavy energy-consuming industries and toward a more energy-efficient economy — energy consumption growth trailed GDP growth by half in the first quarter — it may be that power consumption has become a less accurate barometer of manufacturing health.

When analysing foreign demand, Chinese officials favour the Baltic Exchange Dry Index, which measures global shipping activity of commodities such as iron ore, soybeans and coal.

The index tumbled to levels unseen in 20 years at the end of 2008, when China’s imports sank as de-stocking ran its course.

This year, however, the index offers a less telling read on China’s demand for raw materials because the State Reserves Board has embarked on a commodities buying binge. Thus commodity imports might just be sitting in the reserves instead of going to factories.

In more developed economies, services, rather than manufacturing, account for the biggest chunk of GDP, which might explain why Western economists tend to focus on money supply rather than power consumption and shipping gauges.

After China’s money supply surged a record 25.5 percent in March as banks ramped up lending, foreign investment banks’ knee-jerk response was to upgrade their forecasts for China GDP.

But while money supply might hold the key to economic activity in Western countries, in China now, a lot of those loans are policy-driven rather than a result of market forces. Much of that has been recycled into banks, as indicated by a 29 percent jump in time deposits this March.

Western economic theories have not been very successful in analysing Japan, which managed to defy the Phillips curve by having both low inflation and a tight job market for years. They might be equally less helpful in analysing the Chinese economy, which is dominated by the government and its agencies.

Despite the problems, it is not for nothing that leading indicators, which include things like money supply and the stock market, are called “leading”, and coincident data, which includes things like power consumption, are called such.

Leading indicators were about a year too early to call the economic recovery that started around 2002, while the coincident data has performed largely in tandem with the real economy.
Currently, the uptick on the coincident index is hesitant while the bounce in the leading index is quite determined.

Perhaps this is a sign that an economic recovery — which has caught the imagination of economists and investors but has yet to convince Chinese leaders — is on the way, but its actual start might be later than what the market believes.

— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund —
(Editing by Mathew Veedon and Sonya Hepinstall)

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