Out With The Old, In With The New

BMI View: While the outlook for China's traditional economic growth drivers such as heavy industry and real estate construction remains cloudy, the outlook facing the more consumer-focussed industries is relatively strong over the medium term. Overall, though, as the traditional sectors remain the dominant drivers of the economy, we remain below consensus in our real GDP growth outlook, and caution that the inevitable bursting of the ongoing credit bubble could also serve to undermine the profitability of the consumer-focussed industries. We are revising up our forecast for 2013 to 7.6% from 7.5% previously, while maintaining our downbeat forecast for 2014 of 6.7%.

The bullish and the bearish case regarding China's economic growth outlook both have merit. As regular readers will know, we have been in the bearish camp over recent years, arguing that the excessive credit-fuelled nature of the economic expansion would result in a painful hard landing. This remains our central case. Despite the recent pick-up, economic activity remains meagre on the whole, at a time when credit growth is still rising almost 20% annually from an already-high base. It is difficult to dismiss the importance that the largest recorded credit boom will have on economic growth once it finally ends, as all credit booms do. That said, in an emerging economy in excess of US$8.0trn, there are clearly areas of strong growth and opportunity.

Old Versus New China

Stabilisation Not A New Upswing
China - Average Of Official And HSBC PMI Indices

BMI View: While the outlook for China's traditional economic growth drivers such as heavy industry and real estate construction remains cloudy, the outlook facing the more consumer-focussed industries is relatively strong over the medium term. Overall, though, as the traditional sectors remain the dominant drivers of the economy, we remain below consensus in our real GDP growth outlook, and caution that the inevitable bursting of the ongoing credit bubble could also serve to undermine the profitability of the consumer-focussed industries. We are revising up our forecast for 2013 to 7.6% from 7.5% previously, while maintaining our downbeat forecast for 2014 of 6.7%.

The bullish and the bearish case regarding China's economic growth outlook both have merit. As regular readers will know, we have been in the bearish camp over recent years, arguing that the excessive credit-fuelled nature of the economic expansion would result in a painful hard landing. This remains our central case. Despite the recent pick-up, economic activity remains meagre on the whole, at a time when credit growth is still rising almost 20% annually from an already-high base. It is difficult to dismiss the importance that the largest recorded credit boom will have on economic growth once it finally ends, as all credit booms do. That said, in an emerging economy in excess of US$8.0trn, there are clearly areas of strong growth and opportunity.

Stabilisation Not A New Upswing
China - Average Of Official And HSBC PMI Indices

Old Versus New China

Commentators are increasingly talking of an 'old China' and a 'new China', with the old China referring to the low value-added infrastructure investment that has characterised the past few years of growth, and the new China referring to the high value-added consumer and services driven growth that is hoped will take over. The contrast is very neatly illustrated in the following chart. On the left hand side you have the Shanghai Industrials Index, made up of the conglomerates that have dominated China's resource allocation over recent years, which has been in a structural bear market. On the right hand side you have the ChiNext, an index made up of high-growth tech-heavy companies, which has been in a soaring bull market.

Two Contrasting Outlooks
Shanghai Industrials Index Vs ChiNext Composite Index

'New China' Is Booming

Within China's new economy there are a number of industry sectors witnessing rapid growth. E-commerce is an area which is hitting the headlines of late, with the likes of Alibaba's TMall, JD.com, and Tencent leading a market that has risen exponentially in recent years, and accounts for over CNY150bn (US$24.5bn) according to some estimates. Our pharmaceuticals team continues to see double-digit growth in both healthcare and pharmaceutical spending over the coming years. China's IT and semiconductor industries also continue to grow at a blistering pace. These industries are likely to continue outperforming, and gaining in relative strength as China's economy transforms.

Shanghai Free Trade Zone A Positive Sign

The construction of the Shanghai Free Trade Zone will help to further propel the free-market driven sectors of China's economy, and is a sign of the potential that new China holds. As part of its push towards eventual liberalisation of the Chinese yuan, Beijing has officially opened the country's first free trade zone in Shanghai. Full details have yet to be announced but the free trade zone, spanning 29 square metres, will see the central government loosen regulations across 19 industries, from banking to shipping and even culture, while also piloting reforms in several financial products and permitting a freely convertible yuan.

Strong Yuan Supporting Domestic Consumption

The People's Bank of China's decision to appreciate the yuan is no doubt providing a boon to the domestic consumer market even as it reduced external competitiveness. The yuan has appreciated significantly in real effective terms this year, lowering input costs and increasing disposable incomes for Chinese consumers.

'Old China' Still The Dominant Force

Regarding the idea that the new China can take over the growth reins, there are two significant obstacles. Firstly, the old China remains the dominant driver of the overall economy. Indeed, the recovery in economic activity over recent months, as seen by the rise in the purchasing managers' indices back above 50, has been largely down to the boost in construction activity rather than the boom in the service/consumer sectors. Indeed, following on from the strong property sales figures seen in H113, construction activity has begun to pick up, perhaps with the help of the renewed push to roll out affordable housing. The real estate sector remains the major driving force in the Chinese economy, and it is fuelled by easy credit, which, despite slowing, is growing far in excess of nominal GDP.

Bubble Still Growing
China - Total Social Financing Stock, % chg y-o-y

This brings us to the second obstacle. New China has certainly benefitted from the surge in credit growth and the appreciation of property prices. During credit and asset bubbles, resources are typically drawn towards high order areas such as real estate development, but as peoples' perceived wealth increases, so too does consumer spending. While impossible to calculate, we believe that the abundance of cheap credit and the appreciation of home prices has played an important part in driving sectors of the economy that at first do not appear to be credit sensitive. It is only once we see credit growth begin to turn down, as it inevitably will over the coming years, that the negative consequences will emerge. Regarding our real GDP growth forecasts, we are revising up our forecast for 2013 to 7.6% from 7.5% previously, while maintaining our downbeat forecast for 2014 of 6.7%.

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Geography: China
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