While China's excess debt problems have been extensively documented, the overall economy appears to also be slowing substantially as a result of the decline in the most recent credit impulse, noted as recently as one week ago when we reported that "Chinese Loan Demand Dropped To All Time Low." Overnight, the latest warning about China's economy came from the authors of the China Beige Book, a quarterly survey that tracks the world’s second-largest economy, who said that recent stability in the Chinese economy masks deep-seated problems that threaten to rattle global markets in advance of a leadership change next year, and added that ignoring these risks is shortsighted.
As reported by the WSJ, data from the group’s Q3 survey of 3,100 Chinese firms and 160 bankers point to some potential problems. New growth engines intended to shift the economy away from investment toward consumption-led growth are increasingly wobbly as corporate cash flow is squeezed and Beijing doubles down on traditional engines to stabilize output, the China Beige Book says.
“I’d find it earth-shatteringly surprising if we don’t have a significant problem between now and China’s leadership change” in the fall of 2017 when the 19th Party Congress convenes, said Leland Miller, China Beige Book’s president. “This is not a stable economy. It’s one that twists and turns and happens to end up at the same spot. There are real problems below the surface.”
More troubling, the report notes, growth in China’s service industry, a cornerstone of its planned transition to a new and more sustainable economic model, weakened during the third quarter as financial services, private healthcare, telecommunications, media and other subsectors flagged. In retail, the apparel, luxury goods and food sectors slowed, it said, as online retailers continued to cannibalize brick-and-mortar sales.
Despite Beijing’s pledge to reduce excess Industrial capacity and pare debt, China remains heavily dependent on government spending to power traditional debt-fueled growth engines, the group said. Much of the economic momentum during the third quarter came from infrastructure, manufacturing, commodities and real estate and many of these sectors are in danger of losing momentum, it said.
As the WSJ further notes, while property sales remained strong in major cities, cash flow in the sector tightened and borrowing increased, a sign that investors should “think about getting off this train sooner rather than later,” the China Beige Book said.“ Deteriorating corporate finances and a rebalancing reversal seem a high price to pay for a quarter’s worth of stability,” the group added.
When China reports Q3 GDP next month, it is expected to goalseek a number around 6.7%, the level it posted in both the first and second quarters. Gauges such as industrial production and fixed-asset investment have been surprisingly robust over the past month. However, the trigger for another potential market jolt in the next few quarters could be the release of particularly weak Chinese service or retail data coinciding with a Federal Reserve interest rate rise or another global event, Miller said. “Right now, the markets are lulled to sleep,” he said. “People become used to the stable China narrative until they start looking more closely into the data.”
For now, however, most are unwilling to look more closely into the data.
Economists say they expect the Chinese economy to remain relative stable through the once-in-five-year leadership change, which is expected to be in October or November of 2017, as long as Beijing continues stimulating the economy enough to avoid a drop in growth. “I don’t think there’s going to be a crisis next year,” said Julian Evans-Pritchard, an economist with Capital Economics Pte. “But they often take their foot off the pedal too much, then tend to panic again and put it back on, creating a lag.”
The Bank for International Settlements warned last week that mounting leverage raises the risk of a financial crisis in China. The nation’s total debt, led by rising corporate obligations, is on target to reach 253% of gross domestic product by the end of 2016, a doubling over the past eight years, according to credit ratings agency Fitch Ratings Inc.
It wasn't all bad news however: courtesy of the recent wave to preserve zombie enterprises and near-insolvent corporations, the Chinese job market remains strong. The manufacturing outlook improved with new domestic and international factory orders picking up and deflationary pressure on industry ebbing. “It was not a disaster of a quarter,” Mr. Miller said.
“But it’s a lot more negative than people think.”