GDP Growth Alert: Slowing China and Hong Kong

At the time of writing, China, Korea, Indonesia, Singapore and Taiwan have reported first-quarter GDP numbers. Sequentially, growth slowed in each of them. The major disappointment was China, where growth missed the elusive 8% target primarily owing to weaker exports.
Weakness in external demand also weighed on aggregate growth performance in the rest. In Singapore, exports fell 9% year-on-year in real terms, marking the sharpest fall since 2010. Korea was a slight exception – volume exports did manage to rise by 7% year-on-year, but the benefits did not filter down to manufacturing owing to high inventories.
A similar pattern is likely for countries which have not reported first-quarter GDP. Export performance has been very weak, either declining or remaining flat during the quarter. Domestic demand, as measured from trends in consumer and business sentiment surveys is starting to show signs of fatigue even in the Philippines and Thailand. In India, the inability to pass critical legislation continues to weigh on investment activity.
Purchasing Managers Indexes (PMIs) in April also do not indicate an improvement. With the exception of Indonesia, all countries reported a weaker PMI and, more importantly, new export orders faltered across the board. Another feature is that the orders-to-inventory ratio has deteriorated, implying that an involuntary inventory build-up is happening.
Where do we go from here now? Will growth recover and can policy speed it up? Our view is that a modest recovery should set in probably from the third quarter. Our view is based on the following considerations:
  • The US economy is still healing. Despite the drag from fiscal policy, the on-going improvement in the housing market and household finances is a positive and durable development. More importantly, the tech cycle has continued to strengthen, a critically positive development for electronics exporters: Korea, Singapore and Taiwan.
  • Inventory destocking should at some stage become less of a drag on manufacturing output. This should particularly benefit Korea and Thailand, where exports are failing to have an impact on production.
  • Capital issuance from the region has been unusually strong and should over a period of time stimulate fresh investment activity, particularly in the non-tradables sector.
The role of policy is, however, likely to be moderate, except in select Southeast Asian economies. This is due to both resilient labour markets and institutional constraints. Unemployment rates have remained low in most countries and new job creation in the services sector has been fairly strong. For example, China added 3 million new jobs in the services sector in the first quarter.
Institutional constraints are also manifesting, either in the form of limited fiscal space, as in India, or weak central-local government spending arrangements in China. The Indonesian authorities are having to compromise on development spending owing to a sharp run-up in subsidies.
The Philippines and Thailand are the exceptions, where fiscal policy will likely be used more aggressively for infrastructure development. As for monetary policy, real rates are already supportive of growth. Lowering them further could potentially give rise to asset bubbles. Asset prices in general are already quite sanguine and have diverged from the fundamentals.
Overall, we believe that recovery is likely to take its own course and be moderate given the absence of either strong global demand or fresh policy stimuli. This should ensure a period of low inflation and pressure on corporate margins.
We look at China and Hong Kong in this article. We analyse the economies of India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand in subsequent articles.  
GDP growth eased to 7.7% year-on-year in Q1 2013, implying a 6.1% quarter-on-quarter seasonally adjusted annual rate on our calculation. In our view, sluggish actual export growth has been a key factor.
But this has been masked by irregularities in export declarations, which have inflated the data on exports to other Asian economies – especially Hong Kong – and also show up in an unusually large contribution from exports to “customs’ special control areas”, such as bonded zones.
Export growth. We think the irregularities point to a rise in financial capital inflows disguised as exports in the face of capital controls. After adjusting for the irregularities, we estimate that year-on-year export growth in US dollar terms picked up only modestly in Q1 to 10.6%, compared to headline growth of 18.9%, and was only 5.7% in April, compared to headline growth of 14.7%.
Consumption and investment. Consumption growth slowed due to decelerating income growth and tighter rules on government spending. Growth of investment in infrastructure and real estate remained robust in early 2013, benefitting from rapid expansion of lending, especially non-bank lending, although investment in manufacturing remained affected by pressure on profitability and spare capacity in several key sectors.
Overall, in our estimate, domestic demand growth was sustained through April, as underlined by the pick-up in growth in “normal” imports used in China’s own economy to 13.6% year-on-year in real terms in Q1 and 18.6% in April. We are less concerned about the import data than about the export data.
Real estate sector. After a surge in the first two months of 2013, activity in the real estate sector slowed somewhat in March, with slower growth of sales and amount of floor space started.
In the coming months we expect growth of property sales, starts and completion to be affected by calls by the State Council in March to reinforce tight property policies and follow-up by some cities as part of the government’s effort to “rein in housing prices”.
Housing prices have risen again since mid-2012. In our estimate, they are now up 5% year-on-year nationwide. However, cities actually have some leeway on those policies. In many parts of the country, the objective of reining in housing prices is increasingly being interpreted as ensuring that they do not rise faster than incomes.
We think this interpretation by policymakers makes a new tightening of property policies less likely. Meanwhile, strong lending in the past nine months should support property construction in 2013.
GDP 2013 forecast. Looking ahead, after a weaker than expected Q1, we revised down our GDP projection for 2013 as a whole from 8.4% to 7.8%, both due to the impact of the weaker start and because the data for the start of the year suggests somewhat slower sequential momentum into Q2 than expected.
Real estate and infrastructure investment should remain supportive to growth. However, concerns about financial risks may trigger additional regulatory tightening and should limit the expansion of non-bank lending.
While profits are recovering somewhat, we think corporate investment will continue to face some downward pressure from spare capacity.
On balance, domestic demand may struggle to re-accelerate by itself during 2013. Our forecast assumes some positive impact of a projected improvement in demand through 2013 in the US, Europe and Japan on China’s exports and sentiment. Thus, while having revised down our Q2 quarter-on-quarter growth forecast, we expect a bit more than 8% quarter-on-quarter seasonally adjusted annual rate GDP growth in H2 2013.
Inflation is not an issue, in our view. CPI inflation edged up to 2.4% in March on higher food prices. However, with global commodity prices still benign and continued downward price pressures in manufacturing – PPI inflation was -2.6% year-on-year in April – core inflation remains low. We do not expect CPI inflation to get much higher than 3% this year; the government’s target is 3.5%.
Policy outlook. The government has in recent months implemented some regulatory measures to improve transparency and constrain the growth of non-bank lending, the less strictly regulated part of the financial system. We expect policymakers to take some more such steps, although, with the recovery not particularly strong, we foresee no change in the headline monetary policy stance any time soon.
At the margin, policymakers’ concerns about financial risks and lending by local government investment platforms has shifted the balance a bit from the traditional emphasis on bank lending oriented stimulus to pure fiscal stimulus, financed by government bond issuance. The overall fiscal deficit is budgeted to rise by half a percentage point of GDP in 2013 to 2% of GDP under conservative revenue estimates, giving the government some flexibility.
FX outlook. Recent CNY/USD appreciation and depreciation of the Japanese yen have led to a 7% appreciation of China’s real effective exchanger rate since July 2012, and the CNY now seems broadly fairly valued from a (medium-term) macro perspective.
Meanwhile, though, net balance of payment (BOP) inflows remain sizeable, reflecting the structural surplus on the current account and from net FDI as well as renewed financial inflows. In Q1 the net BOP surplus was US$157 billion on a flow basis.
These inflows complicate efforts to make the exchange rate regime more flexible, a reform area that seems to have gotten a clearer mandate from the top leadership recently.
Responding to the financial inflows, the government in early May took measures to make it harder for banks to facilitate financial inflows and to clamp down on companies dressing up inflows as export revenues. The key challenge in moving to more flexibility is guiding the CNY to a level from which risk is truly two-way without damaging the real economy too much.
Risks to the forecast. Short-term risks to our forecast include a weaker global outlook. Domestically, investment may disappoint if concerns about leverage, shadow banking and lending by local government investment platforms lead to more drastic measures than we anticipate. However, there are also upward risks, keeping our forecast balanced.
The financial risks are also a medium-term issue. In our view, non-bank lending has expanded too rapidly since early 2012 and, following recent measures, there is a further need to strengthen regulation to improve transparency, and rein in risks and the pace of expansion of in the non-bank financial sector.
However, we think that the risk of a systemic financial crisis that overwhelms the economy and the financial system remains modest, taking into account broad-based growth in the real economy, macroeconomic strength and a liquid, easily funded banking system (with a loan-to-deposit ratio of 0.7).
Long-term view. We expect potential GDP growth to moderate from around 8.5% in the coming years to 7% by 2020 and 5-5.5% by 2030.
In terms of structural reform, the State Council statement on the economy of early May confirmed our view that there is a fairly broad mandate for further movement on better pricing of resources and utilities and on financial reform, including on interest rate liberalization, a more market-based exchange rate and a controlled opening of the capital account.
With Prime Minister Li Keqiang leading economic policy making, we think prospects are also good for more progress on guiding urbanization along more balanced lines, with migrants getting access to public services and affordable housing, and the associated need for change in the intergovernmental fiscal system.
So far there seems less of a mandate for substantial movement on levelling the playing field between SOEs and other companies. We also do not expect quick movement on rural land reform and population policy, two areas where philosophical and heritage issues tend to reduce the speed of change.
We expect the government to focus more on reform in the coming six months and to have a better understanding of the reform directions of the new leadership at the time of the third plenum of the Communist Party of China, likely in October this year.
Hong Kong
Growth momentum stalled in the first quarter of 2013, when Hong Kong’s economy expanded a mere 0.2% quarter-on-quarter seasonally adjusted annual rate. The slowdown was due to net exports, which subtracted 2.6 percentage points from headline growth.
Exports of goods and services expanded 1.9% quarter-on-quarter seasonally adjusted, down from 4.4% in the last quarter of 2012. In contrast, domestic demand and imports grew at a brisk pace.
Private consumption expanded by a significant 4.9% quarter-on-quarter seasonally adjusted – the highest rate since records began in 1990. This more than offset weak investment, which contracted 1.1% quarter-on-quarter seasonally adjusted and year-on-year and boosted imports by 3.1% quarter-on-quarter seasonally adjusted.  
Hong Kong growth can in large parts be explained by growth in China and the US. Links to China are mainly through tourism, real estate, and transhipments, while links to the US and the global business cycle more broadly are through the financial sector and port services.
Regressing Hong Kong growth year-on-year on its Chinese and US counterparts, we obtain highly significant coefficients: A one percentage point boost to mainland Chinese growth raises Hong Kong growth by 0.7 percentage point, while a similar boost to US growth raises Hong Kong growth by 1.4 percentage points.
GDP forecasts. With our China economist projecting growth of 7.8% this year and our US economist projecting growth of 2%, Hong Kong should log growth of 3% this year.
On the same basis, Hong Kong should grow 4.8% in 2014. Inflation ran at 3.6% in March and 5.4% on quarter-on-quarter seasonally adjusted basis. Going forward we project inflation to reach 4.1% year-on-year by end-2013 and 4.5% by end-2014.
Policy outlook. The prudential property measures announced in February are showing some effect. Property transactions fell to 3,400 units in April, close to the 3,300 low recorded in the immediate aftermath of the Lehman collapse in 2008. Prices of high-end apartments stabilized since October and the average apartment price fell in March, the first time in 14 months.
In April, the Hong Kong Monetary Authority eliminated limits on Chinese yuan net open positions and CNY liquidity ratios, in effect treating the Chinese currency like any other in Hong Kong. Also, an interbank rate for offshore renminbi will be launched in June, covering tenors from overnight to 12 months
FX outlook. The announcements of the Bank of Japan to double its money supply over two years have not gone unnoticed in Hong Kong. As US data improved and treasury yields rose, the HKD had moved from the strong side of the currency band to trade close to 7.8. The currency is back at 7.76, or just within a whisker of the strong side of the band.
At the same time, the yield curve moved down over the past three months, by about 4.5 basis points at shorter tenors (up to 2 years) and around 20 basis points at longer tenors (5 years and above). We do not expect more FX intervention at this stage, given that US long-term rates should rise henceforth.
About the Author
This article is excerpted from “Asia Navigator,” a report by Royal Bank of Scotland and affiliated companies that was published in May 2013. It has been re-edited for conciseness and clarity.  

Photo credit: Maxim Blinkov/


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