Economic Outlook: Sustainable growth in China

The outlook for the Chinese economy remains a "soft landing" and not a recession. The implication for the construction market suggests that growth will continue, but expectations for the rate of expansion have diminished and the risks to the forecast have increased.

While China's economy slowed during the recession, largely due to reduced demand for its exports, it did not experience recession itself, thanks to massive stimulus spending from the central government.

The construction forecast always envisioned some slowing as the impetus of that spending wore off. But the outlook as receded further, and the risk to the forecast increased, as the result of the housing bubble affecting portions of the residential market.

The key unknown is how fast the property market will slide. The central bank has suggested that prices have reached a "turning point", mooting the implications of a 20% fall. Prices will continue to correct over the next quarter or more, and, should the government fear the knock-on effects on construction and local government debt, authorities may overreact - as they did through the 2008-2009 global financial crisis - loosening home purchase restrictions, pumping liquidity back into the market and triggering another boom-bust cycle.

Housing bubble

The good news is that the housing bubble does not impact all forms of residential construction, and government policy on social housing could offset much of the residential property downturn.
The government aims to build 36 million such apartments by 2015 to mitigate potential social unrest by providing housing for the millions of workers who have migrated from rural to urban China.

To put the scale of the effort in perspective, 36 million apartments would house the population of Germany. There remains some scepticism as to whether this number of new units will actually be constructed, and the quality of the units built so far appears to be mixed. Nevertheless, the policy goal is clear, and China has a track record of achieving policy objectives.

It is important to note that China's construction markets, like its economy, are going to see reduced growth, not a contraction. There will also be important regional differences. Provincial China is showing much resilience, but strength inland will not be enough to offset weakness along the coast.

Indeed, some inland areas have actually gained momentum, but the coast is twice the size of central China, so two speed growth rates would need to be sustained for some time to bring about convergence. It is no surprise that the coast is bearing the brunt of the slowdown as it has seen the greatest domestic credit tightening, has the fastest correcting property market and faces the greatest exposure to weak export potential.

While the coast is dragged down by these factors, inland China - particularly the west - is buoyed by China's mainstay; government funded investment spending, primarily on infrastructure.

A downtick in property activity is a prime driver of the coastal slowdown. Commercial sales along the coast are down to 11% year-on-year, from rates of nearly 20% last summer. This is affecting construction, with growth in "floor space started" down to 21% in October from nearly 30% in August.

Given the coast accounts for 51% of total construction activity (in terms of square metres under construction), a coastal slowdown weighs heavily on the national picture, with investment in real estate now starting to slow nationally.

Sustainable path

The government is now unveiling development plans for key sectors under the country's new five-year plan, specifically steel, construction materials, services, mining resources and biotechnology. These plans flesh out the broad policy blueprint with specific goals to move China to a more sustainable development path.

The plan for the steel industry calls for a more rational geographic distribution of steel capacity in the country, a significant improvement in raw material supply safety, aligning the quantity and quality of steel output with national economic development, achievement of international energy-conservation and environmental- protection standards, and attainment of strong global competitiveness by a few steel companies.

With annual growth of the construction-materials industry in China projected to slow to 10% in the next five years (from 26% over the past five years), the industry will undergo a major consolidation and adjustment.

This will be reflected by continued retirement of outmoded capacity, more aggressive restructuring and mergers of construction- materials producers, as well as geographic redistribution of capacities. For example, the number of cement manufacturers will be cut by one-third by 2015.

With consolidation, the concentration ratio for cement output will be raised by 10 percentage points, and that for float glass by nearly 20 percentage points, again with implications for those sourcing these materials. Another key aspect of the construction-materials plan is the adjustment of the product structure of the industry - companies will be encouraged to extend their operations along the value chain and develop high-end and new-type "green" construction materials.

The expanded plan has implications for the type of construction to be expected in China. For the first time in recent history, there is a residential cycle in China as opposed to a gradual slowing. However, non-residential structures and infrastructure will behave more typically.

Infrastructure spending has been, and will remain, the fastest growing segment of the construction industry.
While issues with rail safety have delayed high speed rail construction, financing activity for this endeavour has recently picked up and new work cannot be far behind.

Within non-residential structures, industrial buildings pose the greatest opportunity in the near term as manufacturing facilities change regional concentration and are upgraded. In the longer term, the push to services will move office construction to the fore. Commercial buildings remain the laggard until the Chinese consumer gains more confidence.

China's economic slowdown suggests a moderating construction expansion moving forward. However, as the imbalances in the housing market indicate, moderation can create a more stable environment and the fleshed out five year plan will target construction more specifically to the country's needs.