It’s no secret that Beijing’s ‘official’ GDP prints likely overstate the pace at which China’s economy is growing. In fact, the numbers may be grossly exaggerated, as some analysts say the real rate of expansion is somewhere on the order of 4% (as opposed to 7%).
We’ve noted on any number of occasions that multiple key indicators — such as rail freight volume, industrial production, electricity consumption, etc. — suggest the dreaded “hard landing” is in fact here, and if Beijing fails to figure out how to balance a sharp decrease in shadow financing with the need to boost credit creation (i.e., if China can’t navigate the impossible task of deleveraging and re-leveraging simultaneously), things could get materially worse before they get better for an economy that’s attempting to mark a very difficult transition from investment-led growth to a consumption-driven model. For more on transparency and why the real rate of growth in China’s economy is “anybody’s guess”, see “Guessing Game: China's 'Real' GDP Growth Could Be As Low As 3.8% [7].”
Beyond intentional misrepresentations however, China’s GDP data may suffer from a calculation error that at least one firm claims is endemic across emerging markets thanks to data collection limitations.
FT has more [8]:
The issue centres on the so-called “GDP deflator”, the inflation measure used to convert estimates of nominal GDP into real, inflation-adjusted terms.
The deflator is a broader measure than indicators such as consumer or producer price inflation and is therefore often considered a more useful gauge of overall price pressures in an economy. It is the preferred inflation measure of the US Federal Reserve.
Since GDP is a measure of domestic output, arguably this deflator should only reflect the prices of domestically produced goods and services.
In practice, this means netting out the price of imports in the calculation of the GDP deflator, a routine practice in countries with “robust statistical systems”, as Chang Liu, China economist at Capital Economics, puts it.
For much of the time, a failure to do this might not matter too much. However, at times when import price inflation varies markedly from domestic inflation, such as when global commodity prices are rising or falling rapidly, it matters more..
Because China does not net off shifts in import prices when calculating the deflator for most sectors of its economy, its deflator tracks producer price inflation much more closely.
As a result, Mr Liu says: “China’s GDP deflator is not an accurate measure of changes in domestic output prices. It exaggerates inflation when import prices are rising, and understates it when import prices fall”.
In the first quarter of the year, China’s deflator turned negative for the second time since 2000, coming in at -1.1 per cent. In comparison, consumer price inflation was +1.2 per cent. This means its inflation gap has jumped to 2.3 percentage points, even as it has fallen sharply in the likes of the US, as the chart shows.
If the deflator is, as a result, understated, then real GDP growth is overstated by the same amount.
“A reasonable guess might be that true inflation was 1-2 percentage points higher than the deflator shows. In that case, real GDP growth in Q1 would have been 5-6 per cent [rather than 7 per cent],” said Mr Liu, who added that the lower rate was closer to Capital Economics’ own estimate, based on activity data, of 4.9 per cent.
In other words, when commodity prices are falling, China (and other EMs) may be routinely overstating GDP growth. As a reminder, here are some estimates for 'actual' (i.e. not emanating from Beijing) Chinese economic output:
[9]
While Capital Economics is careful to suggest that this statistical 'error' is baked into estimates like the ones shown above, one is certainly left to wonder whether the understated deflator should be simply one more factor to consider on the way to estimating what the real growth rate in China actually looks like.
In other words, considering the above, it could well be that GDP growth in China is closer to flatlining than anyone cares to admit.
