Blockbuster Chinese growth masks signs of a slowdown

China’s economy registered the fastest annual rate of expansion on record in the first quarter. But the growth figure is skewed by the large contraction in the economy seen in the same period last year, meaning it started from a unusually low base.

Meanwhile, recent leading indicators – which signal future economic performance -  show clear signs of a downturn in the business cycle.

An expansion of roughly 9% for 2021 will keep China at the top of the growth charts this year. However, a return to the trend slowdown that began a decade ago looks set to resume in the second half of this year. This will be a headwind for global financial markets.

What does the data show?

The National Bureau of Statistics of China reported on Friday that GDP grew by 18.3% year-on-year (y/y)in the first quarter, up from 6.5% in the fourth quarter of last year.

That was a touch slower than we had anticipated and below the Reuters consensus for an increase of 19%, but still the fastest rate of growth on record since quarterly figures began to be recorded in the early 1990s.

The strength of the annual rate of growth in the first quarter needs careful interpretation and actually masks signs of a slowdown in economic activity.

After all, GDP declined by 6.8% y/y in the first quarter last year as the authorities imposed a strict national lockdown in order to contain the outbreak of Covid-19. The result of this is to flatter the annual rate of growth, known as a base effect .

The pace of GDP growth in seasonally-adjusted, quarter-on-quarter (q/q) terms actually slowed to just 0.6% q/q from 2.6% q/q in Q4 2020. Given that effective handling of Covid and swift policy support means that China’s economy has already enjoyed a V-shape recovery, growth is now settling down to slower, more sustainable rates.

Signs of a slowdown

There were signs in the March activity data, released at the same time as the national accounts for the quarter as a whole, that the key drivers of the post-Covid recovery have begun to weaken.

Retail sales remained buoyant, expanding by just under 34% y/y in March, the same rate of growth registered across January and February. However, growth in both fixed asset investment and industrial production, which have been the pillars of the recovery during the past year, slowed. There are reasons to think that these props to growth are likely to weaken during the course of this year and into 2022.

For a start, growth in manufactured exports looks set to decelerate after a period of strong demand during the global lockdown. The Caixin manufacturing purchasing managers index (PMI) has declined for four consecutive months since its November peak as manufacturers have cleared backlogs of work. (The Caixin manufacturing PMI is derived from a survey of manufacturing companies in the private sector and is designed to measure activity). 

Strong global growth means that demand for manufactured goods is unlikely to collapse altogether. But with the re-opening of economies around the world likely to result in a re-orientation of consumption back towards services and away from manufactured goods, it seems that the best days for industry in this cycle are behind us.

Meanwhile, the withdrawal of policy support is likely to weigh on construction activity. As we noted at the time, with the experience of 2015 still fresh in the memory of the authorities, when an over-zealous tightening of policy appeared to crash the economy, the government’s targets for the “normalisation” of policy this year are not very ambitious. And it is notable that despite some drift higher, short-term interest rates are still low. Nonetheless, the authorities have since stepped in to ask banks to rein in lending to the real estate sector amid fears that easier policy will fuel another property boom. This was in addition to previous moves to tighten lending quotas to the sector.

Data published on Monday showed that growth in total social financing slowed to 12.3% y/y in March, from 13.3% y/y in February, driven by a moderation in bank lending, along with corporate and government bond issuance.

As the chart below shows, that caused the credit impulse, which is an important driver of the highly leveraged (i.e. debt dependent) economy and tends to lead real activity by about nine months, to decline sharply last month having reached a peak in October last year. The credit data are also distorted to some degree by base effects, but it seems likely that the impulse will continue to trend down and turn negative in the months ahead.


A continued recovery in other parts of the economy, particularly consumption as the services sector continues to normalise and the labour market recovers, should cushion the slowdown. But even so there is little doubt that growth next year will be slower than this year at 5.5-6% - by no means a disaster, but a slowdown all the same and resumption of the trend deceleration that began a decade ago.

What a slowdown in China means for markets

A slowdown in China will be a key theme for global financial markets. At the very least, fading Chinese demand will mean that further gains in commodity prices, particularly industrial metals, will need to be driven by the rest of the world. Similarly, investors in emerging market equities will need to be more selective if China offers less impetus to corporate earnings. But there should also be opportunities for investors, perhaps most obviously in fixed income markets.

Finally, despite the authorities aiming to engineer a soft landing by tightening policy only gradually, risks remain. In particular, there is a clear risk that fears of a hard landing (growth flattening) and debt crisis will rear their head at some point once the slowdown has become more obvious. As we have seen countless times in the past, such a scenario would be likely to trigger a nasty sell-off in EM financial markets, even if fears of a hard landing and crisis are overdone.





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