Right up until Beijing’s move to devalue the yuan temporarily shifted the market’s focus away from Chinese economic data in favor of the daily RMB fixings, Western investors watched closely every evening for any signs of just how “hard” China’s landing is ultimately shaping up to be.
Of course the data point par excellence when it comes to gauging the degree to which the Chinese economic engine is sputtering is the all-important (and all-fabricated) GDP print, which has a way of conforming to Beijing’s 7% “target.”
The interesting thing about Chinese GDP data is not that it’s hopelessly overstated. Everyone knows that. There’s no telling what the “real” number is and the best way to get a read on what’s actually going on is probably to look at the so-called Li Keqiang index which tracks the variables the Chinese premier thinks are the best way to approximate output, but then again, who knows.
What’s interesting is the degree to which China’s GDP prints may be overstated as a result of something other than outright manipulation and fabrication: namely, the country’s inability to accurately measure the deflator.
We’ve discussed Beijing’s deficient deflator math [8] on a number of occasions. Here, in a nutshell, is the “problem”:
Effectively, the assertion is that China’s deflator simply tracks producer prices, and thus when import prices slide, the deflator understates domestic inflation and therefore overstates real GDP. In the simplest possible terms: when commodity prices are falling, China (and other EMs) may be routinely overstating GDP growth. Here’s an excerpt from FT [9]:
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 Cang Liu, China economist at Capital Economics, who added that the lower rate was closer to Capital Economics’ own estimate, based on activity data, of 4.9 per cent.
Well don't look now, but the deflator turned negative again in Q3. Here's WSJ [10]:
China’s economy is like Tom Brady’s footballs: Deflation may improve performance.
The world’s second largest economy registered an official 6.9% growth rate, in inflation adjusted terms, in the third quarter compared with a year ago, just a smidgen off the government’s official target of 7%.
But in nominal terms, it grew just 6.2%, the slowest top-line growth for the economy since 1999. That is distressing news for anyone in China with a lot of debt, as slow nominal growth makes paying off loans more difficult. With credit still expanding double digits, deleveraging writ large remains a far off dream.
The reason the real GDP figure came in higher than nominal GDP is that the “deflator” that Beijing’s statisticians applied was negative for the second time this year. It was also negative in the first quarter.
It isn’t clear, though, if a negative deflator is warranted. While producer prices are shrinking, consumer price inflation actually ticked up last quarter, averaging 1.7%, compared with 1.3% in the second quarter, when the deflator was positive.
So, it looks as though a failure to net out import prices is once again causing China's deflator to track producer prices more closely than it should, leading to a large discrepancy with the CPI and, in the end, overstated GDP growth.
Put simply: They're habitually understating inflation for domestic output which means that "real" GDP is probably less "real" than nominal GDP.
What is more disturbing is that as the WSJ simply points out, Chinese credit continues to grow at a pace nearly double that of the overall economy...
... which as the WSJ summarizes: "is distressing news for anyone in China with a lot of debt, as slow nominal growth makes paying off loans more difficult. With credit still expanding double digits, deleveraging writ large remains a far off dream."
Assuming what both Citi and UBS have said previously, namlye that the world is approaching its maximum debt capacity [11], is a very big problem for China and the rest of the world.
That's the key takeaway.
Here's a bit of color from BNP:
In nominal term, GDP growth has slowed more sharply to 6.2% y/y in Q3 from 7.1% in Q2 and 6.6% in Q1, on lower inflation. GDP deflator dipped to -0.7% y/y from 0.1% in Q2, thanks to deeper deflation in the secondary industry (-5.3% in Q3 vs. -4.1% in Q2). Inflation of the service sector stayed flat at 3.1% y/y, thanks to decent growth in labour cost and rental prices.
What this means is that when viewed objectively, this was the worst GDP print of the 21st century. Here's the chart going back to Lehman:
[12]
As we've noted before, this is interesting because it points to a specific deficiency in statistical analysis (as opposed to sweeping accusations about a generalized and endemic lack of transparency) and thus seems to merit a response from China’s National Bureau of Statistics.
On that note, we'll leave you with the official response to the above from the NBS:
"In general China’s GDP deflator hasn’t been underestimated, nor has GDP growth been overstated. Both objectively reflect the real situation."
