China growth outlook turning for the better, but on more of the same — Fathom Consulting

May 10, 2016

A farmer walks through a field near a replica of the Eiffel Tower at the Tianducheng development in Hangzhou, Zhejiang Province August 1, 2013. Tianducheng, developed by Zhejiang Guangsha Co. Ltd., started constructing in 2007 and was known as a knockoff of Paris with a scaled-replica of the Eiffel Tower, standing 108 metres, and Parisian houses. Although designed to accommodate at least ten thousand people, Tianducheng remains sparsely populated and is now considered as a "ghost town", according to local media. REUTERS/Aly Song (CHINA - Tags: SOCIETY ENVIRONMENT BUSINESS REAL ESTATE TPX IMAGES OF THE DAY) - RTX1275Z

China’s growth outlook has turned ever so slightly for the better, according to one of the more pessimistic independent forecasters of the world’s second largest economy up until now, but because they think Beijing is about to do a lot more of the same.

“We think China has bottomed out and may be starting to turn towards slightly stronger or more positive growth,” said Erik Britton, co-director at Fathom Consulting, during a presentation on the global economy at Thomson Reuters in London. “(This has) implications for commodity exporters around the world, implications for emerging market economies.”

Most economists and investors agree that it’s become increasingly difficult to get a real sense of how China’s economy is performing. Official economic statistics are timely and frequent, but are often questioned outside and inside the country, for their accuracy, particularly given how quickly they are compiled and how little they are revised.

The trouble also comes from the fact that those who have a view tend to fall into one of two camps: optimists who claim an inside view and who almost invariably say everyone else is too negative, or those who look in from the outside and who perhaps carry around a bit too much gloom.

That makes Fathom’s change of view all the more notable.

About a year and a half ago, the consultancy launched their China Momentum Indicator, which essentially tracks three key indicators that Li Keqiang suggested before he became Chinese premier were a better way to gauge the overall health of the economy than GDP: electricity consumption, rail cargo volume and bank lending.

Back then, that was tracking growth at around 5 percent compared with official estimates of 7 percent from Beijing at the time. The estimate has since fallen to just over 2 percent, about a third of the 6.6 percent consensus view for the current quarter among economists polled by Reuters just last month.

China Momentum Indicator

According to Britton:

“You’ll need a microscope, or very fine eyes, to see what’s going on here, but what’s going on is important. We’ve been talking for a long time about what we think is the wedge between what we think is the true rate of growth in China, the (blue) line there, and the headline GDP data, the (orange) line, that wedge opening up, that gap opening up at the same time, contemporary with the falls in commodity prices globally and the declines in emerging markets and so forth. All of that for us was driven to a large degree by China. What we’re anticipating going forward is that that process will continue, not back up to 6’s and 7’s but back up to maybe 4, maybe 4-1/2 (percent) over the course of the next couple of years. This is big news, not just for China, but for everybody else too.”

Fathom’s improved outlook, however, is not based on hope for success in Beijing’s attempt to re-balance its economy away from manufacturing cheap goods for export to the rest of the world toward domestic consumption and services. Instead, it’s based on a view that China will “double down” on the policies it has had in place since the financial crisis that has helped it outperform the rest of the world economy.

“China is already undertaking a splurge of fiscal loosening to stimulate demand. The way we’re characterising that is doubling down.”

“After the global recession, China started with an already colossally high share of investment in GDP. What it chose to do to avoid experiencing the same sort of economic downturn that the rest of the world did was massively increase that share of investment to levels that almost have never been experienced, not only in China, but in any other country in the history of the world. A massive, massive accumulation of fixed capital which successfully allowed China to ride through the global recession with maybe a modest slowdown in growth to report about in that period of time.”

That investment boom came off a bit along with Beijing’s first attempts to rebalance the economy, but not by much.

“The purpose of that rebalancing was that consumption and services would grow so rapidly that China’s GDP trajectory should stay on course, about a 6-7 percent type of range. That has not transpired.

“The consequence of that is: what do I do now if I’m the Chinese authorities and I feel moved to try and increase, however I can, the growth rate that the economy is achieving? What we’re arguing they’re likely to do is double down on that bet that they placed after 2008-2009. I bet I can invest even more in real estate, in construction, in manufacturing industry, in infrastructure, all of that stuff they did after 2008-2009, even though I’ve already got far too much of that stuff, the fact I’ve got far too much doesn’t mean I can’t have more.”

While there have been plenty of stories in recent weeks written on China’s eventual day of reckoning with its past and current debt binge as well as troubles with its bloated banking system, at the moment, financial market pricing suggests it’s a long way off. So long as that is the case, the International Monetary Fund’s new-found principle of “fiscal space” — borrowing where there is room to do so — applies to China, says Fathom.

“China’s deficit…around about 2 percent of GDP is not great, but it’s not terrible by the standards of other economies around the world. And its government debt position is not bad either, about 40 percent of GDP…That can double without being too problematic,” Britton said.

“That’s all fine as long as you don’t count Chinese government debt contingent liabilities from the banking sector, which are massive, or local authority debt, which is also massive. At the moment markets are not judging that that’s part of the central government’s problem. They might come to do so in due course, and they would be right in our judgment.”

So in the immediate future at least, if China doubles down on fiscal spending while most of the rest of the world chooses austerity and zero interest rates, that suggests a more positive backdrop for global growth. The question is, how long will that last?

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