Schroders Quickview: China - strong growth, fragile foundations
Chinese Q2 GDP beats lowered expectations, but can it continue to defy the sceptics? Schroders Emerging markets Economist Craig Botham remains unconvinced.
- China beats lowered City expectations for Q2 GDP
- China activity increases 7% year-on-year, the same as in Q1
- Sequential growth momentum improves - 1.7% quarter-on-quarter, up from 1.3%
- China growth remains unconvincing
China recovery built on sand
To us this does not look like a recovery built on strong foundations, and there is a parable about the man who built his house upon the sand.
Expectations for Q2 GDP had been lowered thanks to a slew of weak high frequency data, though June recorded one or two improvements.
- Q2 industrial production grew just 0.1% faster, year-on-year, compared to Q1.
- Q2 investment grew at an average pace of 10.3%, down from 13.5%
- Q2 retail sales slowed to 10.2% growth from 10.5%
Given that Q2 GDP last year was stronger than Q1 – providing a negative base effect – it seems odd that GDP did not slow.
Certainly, our in-house model pointed to a consistent growth rate of around 6.3%, down from 6.9% in Q1. Can we reconcile the difference?
Has the equity bubble propped up GDP?
While it would be easy to claim this is a classic case of the authorities fudging the numbers, we will resist temptation.
The breakdown of GDP provided shows the primary and tertiary sectors accelerated whilst manufacturing slowed.
A further breakdown is not available at this stage, but we note that in Q1 a strong performance by the finance industry contributed an estimated additional 0.5% to GDP growth, thanks to brokerage performance on the back of the equity market rally.
Although this rally collapsed in mid-June, brokerage incomes likely outperformed again for most of the quarter.
Our view is that GDP growth built on an equity market bubble is unsustainable, and with a weaker equity market performance likely in Q3, a repeat GDP shock seems unlikely.
China has defied the sceptics for now, but we do not see much in the data to encourage us about the economy’s future.
In another echo of Q1, it is likely that net exports once again contributed a sizeable chunk to GDP last quarter.
But as in Q1, this is not because of a strong export performance (which contracted in the quarter, year-on-year), but because of a weak import performance, thanks to cheap commodity prices.
Again, this is not a sustainable source of growth; a stronger economy will begin to draw in more imports, and commodity prices will not fall forever.
China faces uncertain future
So while China has defied the sceptics for now, we do not see much in the data to encourage us about the economy’s future.
The performance in Q2 looks to have been built upon shaky foundations, rather than the solid rock of self-sustaining growth.
The biblical house built upon sand ultimately fell with a great crash as the weather turned against it – the same fate may not await China, but all sandcastles ultimately crumble.
Important information: The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors. Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.