Economic Outlook: China
By Scott Hazelton25 February 2015
China’s economic growth rate will continue to decelerate in the coming quarters, owing to past excesses and lack of organic engines of growth. Gluts in housing and industrial capacity, as well as the excessive lending that financed them, are weighing down on the economy and stopping the government implementing aggressive stimulus.
Despite the easing of housing purchase restrictions and targeted credit easing for the real estate market, housing price deflation and weak residential construction have continued. Even the export rebound has been unsteady, due to renewed weakness in the Euro Zone and the weak US recovery.
Still, a hard landing is unlikely. A more serious concern and perhaps more likely outcome is that China could enter a prolonged period of low growth.
Housing has been a key issue for China to manage, and housing construction will continue to weaken as house price expectations deteriorate. The government’s housing market restrictions have drastically cooled the market.
Construction starts measured in floor-space terms contracted -9.3% year-on-year in the third quarter of last year and worsened further in November. The downturn was partially due to high base effects – housing starts in January-September 2013 rose +23.3%, and the construction starts decline has moderated from a -27.4% trough in February 2014.
Another drag in real estate is that investment on public housing is tapering-off. This accounts for about half of total new floor space in China, and plans are to start fewer public housing units in 2015 than in 2014. This arguably highlights the growing strains of funding for the ambitious programme – local government finances are weak and there is plenty of supply in some parts.
Still, China plans to start construction of 7 million public housing units in 2015, about 200,000 fewer units than in 2014.
It is important to note that tier-one cities have stronger real estate markets than the rest of China. New private unit sales in Beijing were reported up +28.6% and by +28% in Shenzhen by First Financial Bank in November. Indeed, Beijing set a new land auction record in January with a parcel selling for US$ 1.39 billion, demonstrating continued high demand for developers.
In addition to housing, railway construction has been a key element of both China’s urbanisation strategy and investment pump priming. Chinese rail experts have proposed a new high-speed rail line linking Inner Mongolia’s Baotou city with Hainan’s Haikou city. This would be the world’s longest high speed rail line at about 3,000 km.
If approved, construction would start after 2016. Two new approvals for urban railways have been announced for Hefei and Zhejiang. Zhejiang’s will add 23 railway lines with a total length of 1,413 km. Guangzhou has also announced large-scale metro construction that will add 15 new lines and 229 km of rail between 2015 and 2025 – the largest investment project (US$ 23 billion) in the city’s history.
Indeed, to stimulate investment and stabilise economic growth, the National Development and Reform Commission (NDRC) has approved 43 projects including airports, railways, highways and urban railways since October. In addition, news organisation Bloomberg has reported indications that China is accelerating an additional 300 projects with a value of US$1.1 trillion.
In addition to infrastructure, these would include oil and gas pipelines, health, clean energy, transportation and mining, and suggests concern that economic growth will slip below the level needed to maintain stable unemployment.
In addition to stimulus and major projects, China has announced a series of potentially important reforms. First, it aims to conclude a rural land reform pilot by 2017, covering land expropriation, marketing collective land for business use, rural homesteading and allocation of land appreciation income.
Better financial management of agricultural land is key to a market for land transfers, which is integral to Chinese urbanisation plans and ultimately future investment growth.
Also, Beijing, Guangzhou, Shanghai and Shenzen are piloting real estate investment trusts (REITs) to support funding needs for affordable housing, which is to say commercial housing is excluded.
Currently, affordable housing is funded by local governments, and with a construction target of 36 million affordable housing units in the 12th five-year plan, the cost to develop this housing would exceed US$ 800 billion.
REITs provide a new source of funds during a time of weak real estate market activity and increasing regulation in shadow banking and government debt.
The first chart indicates the slowing of residential construction and the continued importance of infrastructure. Non-residential structures will follow a path closer to housing as export growth will be much more subdued than the post-WTO-entry boom years of the 2000s.
In addition, domestic consumption has not materialised to the extent needed to justify robust private investment.
While interest rates have been cut, profit conditions have only improved moderately. Retained earnings are a main source of Chinese investment financing, and while profits were up +12.2% in 2013 and +10.0% in 2014, these pale in comparison to the +30% to +40% growth of the 2000s.
Also, China’s WTO accession led to Foreign Direct Investment (FDI) flooding into the manufacturing sector. As returns have fallen, the market looks saturated.
Some industries will fare better than others, notably those favoured by China’s central plan. These include ecological and environmental protection, energy infrastructure and grid construction, social facilities, agricultural and water conservation, telecommunications/IT and public services. The government will promote public-private partnerships and implement subsidies and subsidised loans to facilitate easier access to the industries, while ensuring reasonable expected returns for investors. Other priority industries include metals, cement and fertiliser production.
China has moved into a slower growth phase, and it appears this will last some time. Opportunities still exist, but greater care is required to find them and the risk of poor returns has increased. Infrastructure projects, particularly rail and energy, offer the greatest potential, and the larger cities have become safer bets than medium to small cities and the hinterland.