Has China’s Economy Hit a Speed Bump?

Recent data suggests China’s economy may be struggling rather than roaring back from a seasonal slump, and that its impressive headline growth numbers in 2020 hid an incomplete and unbalanced recovery. Forward-looking purchasing manager indices (PMI) reported by China after the Lunar New Year were just slightly above 50, which shows a growing economy, but possibly at a slowing rate that could be worrying to Chinese officials. It’s too early to tell if the recent dips are temporary, cyclical or symptomatic of a greater slowdown, but dependence on the old model of credit-fueled investment and exports may not be sustainable. If not, then projected supercharged growth of 8-9% in 2021 could be unattainable and inconsistent with the Chinese government’s official narratives.

• The Chinese government’s manufacturing PMI fell to 50.6 in February, a nine-month low, from 51.3 in January. Its non-manufacturing PMI, which covers construction and services, was 51.4 in February, down from 52.4 the previous month, possibly reflecting subdued transportation services both domestically and internationally. 
• The private IHS Markit-Caixin PMI, which is more statistically sound and has better seasonal adjustments than China’s official manufacturing PMI, showed similar results.

Moreover, external demand as measured by the PMIs fell to contraction levels in February, dropping below 50, which could indicate the technology and medical equipment shipments from China that had been driving net export growth are running out of steam. That would not be surprising since the rest of the world may have absorbed all the work-from-home technology and personal protective equipment that it can. The global shortage of semiconductors may also be limiting exports. On the other hand, high-frequency indicators show economic activity picking up after the Lunar New Year to pre-holiday levels, which may not show an economy accelerating toward the projected growth of 8-9% for 2021. 

Until now, China’s economic recovery had been mainly supply-driven, based primarily on industrial production, public infrastructure investment and real estate construction, as well as an increase in exports of medical equipment and electronics used for remote work. Demand-side growth, however — in particular, household consumption — continues to lag, especially what apparently is a large build-up in personal savings from depressed consumption.

• Industrial production was up by 7.9% in December and ended 2020 up by 2.8% from a year earlier.
• Fixed asset investment grew by 2.9% in 2020, after rising by 2.6% in the first 11 months of the year. But as in previous months, public investment in infrastructure accounted for nearly all the increase. Private investment increased by 1% on a year-over-year basis in December, slowing from a 0.2% rise in November. Data from China’s National Bureau of Statistics, however, shows the state-owned or controlled enterprise investment was up by 5.3% and real estate construction rose 7%, both of which would have pulled the overall investment growth total higher. 
• External demand came from relatively high net exports, which were influenced by a 13.3% year-on-year increase in medical supplies in December, as well as booming consumer electronics exports (+54.4%) related to remote working arrangements abroad. It’s unclear how long that demand will continue as the pandemic comes under greater control and Western countries return to in-person work and surmount supply chain disruptions.
• Retail sales, however, were down by 3.9% for 2020, with consumption the biggest missing piece of China’s recovery. Retail sales increased by 4.6% in December, below expectations and following a larger 5% gain in November.

There are persistent questions as to whether Chinese economic data measures the same things as Western economic data, which is relative economic prosperity and well-being over time. According to government metrics, China was the only major economy that grew in 2020. GDP surged in the final three months by 6.5% (year-over-year) and, along with increases in the previous two quarters that wiped out the 6.8% first-quarter decline, resulted in total 2020 growth of 2.3%. Real GDP growth has been positive every year since 1976. This year, it has come at the cost of high debt, wasteful investment and lagging consumption. Moreover, China reports data on a production or value-added basis and not in the standard expenditure format used by the rest of the world, which breaks out consumption, investment, government spending and net exports. While this method theoretically matches the expenditure and income methods of measuring GDP, it makes it difficult to separate the sources of growth into their primary drivers.

China reports separate data for investment, foreign trade and some aspects of consumption. But those categories are not directly comparable to GDP expenditure categories. For example:

• Retail sales are a poor proxy for consumption since they are incomplete and do not accurately include services consumption. In addition, China’s retail sales may be exaggerated by government procurement, which would appear under a different expenditure category in standard GDP accounting.
• Likewise, China’s gross capital formation or investment may well be overstated and include public procurement, including personal items paid for with public funds. According to the U.S.-based consulting firm McKinsey & Company, investment accounted for about 93% of the country’s 2020 GDP growth, but China’s methodology makes it difficult to assess that.
• Government expenditure and revenue are opaque in China, which in turn makes it hard to measure public sector debt. The central government lacks a consolidated budget, which hides the true size of fiscal stimulus and, according to data compiled by Bloomberg, may understate actual public spending by as much as 60%.

The direction of Chinese policy may, in fact, be a better indicator of its economy’s current state, as it reflects Beijing’s response to perceived economic conditions rather than backward-looking information that is subject to manipulation. Given the uncertainty in the COVID-19 dominated economy of 2020, the Chinese government dropped its annual growth target and may do so again this year. The 14th National People’s Congress that convenes on March 4 and related meetings will reveal whether that is the case.

• According to the International Monetary Fund in December, China’s “augmented general government deficit,” which combines a number of different budgets beyond just the official central government, was projected at 18.2% in 2020. That is a significant boost to the economy and suggests that China’s real economy may not be as healthy as claimed.
• China faces significant problems with an aging population and shrinking workforce, a growing and possibly unstable domestic debt, and an economic growth model that is exhausted and in need of substantial overhaul.