The growth trade-off gets harder

Financial Mirror (Cyprus) - - FRONT PAGE - By An­drew Bat­son

China’s bet­ter-than-ex­pected eco­nomic data for the sec­ond quar­ter un­der­score just how ef­fec­tive a jolt of stim­u­lus to hous­ing and con­struc­tion can be. The June quar­ter was likely even bet­ter than im­plied by the flat 6.7% year-on-year read­ing for head­line real growth: nom­i­nal GDP growth ac­tu­ally ac­cel­er­ated to 8.4% in 2Q from 7.2% in 1Q. But hous­ing is al­ready cool­ing, as growth in sales and con­struc­tion started turn­ing down in May, and the rest of the Chi­nese econ­omy will fol­low suit in com­ing months.

The in­creas­ingly frothy be­hav­iour of hous­ing prices made a pause in the stim­u­lus seem pru­dent, and the fear of a hous­ing bub­ble will con­tinue to con­strain the gov­ern­ment’s abil­ity to pump up growth to meet its tar­gets.

The sta­bil­i­sa­tion in China’s growth this year has been a thor­oughly “old econ­omy” phe­nom­e­non: nom­i­nal growth in the in­dus­trial sec­tor was ba­si­cally zero in the sec­ond half of 2015, but picked up to 3.5% by 2Q16. De­spite more rhetoric about the tran­si­tion to a ser­vices-driven econ­omy, growth in the ser­vice sec­tor has con­tin­ued grad­u­ally to slow, led by the ex­pected down­turn in the fi­nan­cial sec­tor af­ter last year’s un­sus­tain­able stock-mar­ket boom.

The ac­cel­er­a­tion in credit growth that be­gan in late 2015 was so ef­fec­tive not just be­cause it was larger than ex­pected, but be­cause so much of it was fun­neled into mort­gages, which are now up about 30% YoY. The re­sult­ing bounce in hous­ing sales and con­struc­tion boosted output of steel and other con­struc­tion ma­te­ri­als—which also led, cru­cially, to a bounce in prices as pro­duc­ers strug­gled to ad­just to the rapid change in con­di­tions. That eas­ing in in­dus­trial de­fla­tion lifted, at least tem­po­rar­ily, some of the gloom over Chi­nese heavy in­dus­try.

But the stim­u­lus also had a big im­pact on another set of prices: hous­ing prices in the four large “Tier 1” cities (Bei­jing, Shang­hai, Guangzhou and Shen­zhen). The surge in those top-tier prices eas­ily ex­ceeded that in the last hous­ing up­cy­cle in 2013: an­nu­alised in­creases neared 50% at the peak of the boom, and were start­ing to spill over into other cities (see the chart). The si­mul­ta­ne­ous surge in house­hold lever­age and hous­ing prices posed ob­vi­ous fi­nan­cial risks. But they also cre­ated a po­lit­i­cal prob­lem, as high hous­ing prices squeeze the ur­ban bour­geoisie and gen­er­ate dis­con­tent. Bei­jing has re­peat­edly shifted eco­nomic pol­icy when hous­ing price gains threat­ened to get out of con­trol, and this time proved no ex­cep­tion: some cities im­posed re­stric­tive poli­cies, and the cen­tral gov­ern­ment al­lowed credit growth to slow.

With mo­men­tum from the con­struc­tion re­bound al­ready suf­fi­cient to en­sure 2016’s of­fi­cial tar­get of 6.5% GDP growth is met, the gov­ern­ment’s de­ci­sion was per­haps not a dif­fi­cult one. But this will not be the last time the gov­ern­ment has to make a trade-off be­tween two sets of po­lit­i­cal goals: meet­ing Xi Jin­ping’s im­plau­si­bly-high growth tar­gets, and avoid­ing a prop­erty bub­ble that would im­mis­er­ate the ur­ban mid­dle classes.

Out­side real es­tate, pri­vate-sec­tor in­vest­ment con­tin­ues to be weak—a sign that most com­pa­nies are look­ing beyond the bounce in hous­ing and ex­pect fi­nal de­mand to keep de­te­ri­o­rat­ing. No­tably, nom­i­nal fixed-as­set in­vest­ment by pri­vate-sec­tor com­pa­nies de­clined -0.5% YoY in June, the first neg­a­tive read­ing since the data se­ries be­gan in 2004. So as the mo­men­tum of the hous­ing re­bound fades, there is lit­tle to take its place as a growth driver. In­fra­struc­ture spend­ing by lo­cal state-owned en­ter­prises is still grow­ing by over 20%, but such spend­ing has been fairly con­stant since 2012, and it seems to have few spill-over ben­e­fits. There­fore growth seems cer­tain to soften in 2H16, and so calls for another round of stim­u­lus are only a mat­ter of time.

If meet­ing the GDP tar­gets was the gov­ern­ment’s only con­sid­er­a­tion, then another round of eas­ing could come fairly quickly. But while the po­lit­i­cal im­por­tance of the growth tar­get is clearly very high, so is the po­lit­i­cal im­por­tance of avoid­ing another bub­ble in hous­ing prices. The dif­fi­culty of that trade-off could push the next eas­ing cy­cle into 2017.

This con­straint on pol­icy, in my view, re­flects a new struc­tural re­al­ity for China: fun­da­men­tal de­mand for hous­ing is more or less al­ready at its peak level.

There­fore in­creases in credit to the sec­tor will be plowed less into build­ing more hous­ing and more into trad­ing ex­ist­ing as­sets. Pump­ing credit into hous­ing is, as this year has shown, still a pretty ef­fec­tive tool for sta­bi­liz­ing growth— but one whose costs are ris­ing and whose ben­e­fits are di­min­ish­ing.

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