Wednesday, 15 April 2015

China 1Q GDP: The Cost of Financial Efficiency

China’s 1Q GDP growth of 7% is exactly as predicted/stipulated, and by itself tells us nothing interesting, except that it provides no cover for a much-needed relaxation of current policies.

More interesting is what happened to nominal GDP growth, which slowed to just 5.8% yoy. Although we do not have a quarterly breakdown by expenditure, I estimate that in nominal terms, China’s capital stock was growing by around 13.3% yoy in 2014 (based on depreciating gross fixed capital investment over 10yrs). If so, nominal growth of 5.8% means asset turns, and therefore returns on capital, must certainly be plummeting far faster than that 7% ‘real GDP’ suggests. 

But there is a second calculation to be made. Nominal growth slowed to 5.8% yoy even though the 1Q trade surplus of US$123.8bn is a multiple of the US$16.6bn surplus recorded in 1Q14. The trade surplus was equivalent to 5.4% of GDP in 1Q15 rather than the 0.8% of 1Q14, and that must make a major contribution to the overall nominal GDP growth. When one subtracts the trade balance from nominal GDP to estimate nominal domestic demand one finds China’s domestic economy already at a standstill - it rose only 0.9% yoy in 1Q15.

(Incidentally, I am  not straining for this result - I do these calculations every time).

We can also use the nominal GDP data to explore how money and finance are affecting China's economy. The relationship between money and the economy, and the Chinese population and money, has not yet stabilized, but neither is it deteriorating any more rapidly than usual. Monetary velocity (GDP/M2) continues to deteriorate, although given how badly asset turns must be falling, the deterioration is actually surprisingly modest.   Liquidity preference also continued to fall to new lows, but as with monetary velocity, the continuing fall is no worse than one would expect, extrapolating from historic seasonal trends. 

And finally, I am interested in the efficiency of Chinese finance, expressed as how much additional GDP growth is associated with an extra yuan of finance.  Recovering this efficiency of finance is, after all, an indispensable aim of any reform which hopes to rebalance the economy. For bank lending, over the last 12 months an extra 1 yuan of lending has been associated with only 0.44 yuan of extra GDP. This has not quite stabilized the fall seen between 2011 and 2014, but the rate of decline has clearly moderated.  What’s more, the last year (and in particular the last two quarters) have been marked by the government’s successful attempt to shut down several ‘shadow banking’ lines of finance and squeeze that financing back into straightforward ‘bank lending’.  In the year to March 2015, bank lending accounted for 67.5% of aggregate new financing, up from 54.6% in the same period last year.  Naturally, this shift in the form of financing will tend to produce a decline in the measured efficiency of bank finance. 

So the wider measure - the GDP gain associated with an increase in total new aggregate financing (including bank lending) - becomes the one to watch. And the news is good: the efficiency of finance is improving, albeit only marginally. In the 12m to March 2015, one yuan of extra total financing was associated with 0.302 yuan of extra GDP, up from 0.295 yuan in the 12m Dec 14, and 0.251 yuan in the 12m to Sept 14. In fact, the 12m to March 2015 was the highest reading since 4Q2013 - although it is still less than half the 0.77  yuan achieved during pre-crisis 2006-2009. 
The problem is that these small gains have been bought at an economic cost which is too great to sustain. We have previously laid out how China’s trade data, and its monetary conditions are deteriorating too rapidly for comfort. If in addition, we accept the extraordinary possibility that 1Q nominal domestic demand slumped to only 0.9% yoy, it seems inevitable and indeed unavoidable that some rather extensive belt-loosening will be needed and accomplished in the near future. At which point, we can expect the hard-won gains in financial efficiency to be lost once again.  

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