Evans-Pritchard, who is based in Singapore, says the China Activity Proxy index was started in 2008. For the first four years of its existence it closely tracked the official GDP data.

"Over time we began to see this divergence between the official figures and the proxy," he says.

"The timing of that divergence is very interesting because it starts in 2012 which just happens to be when the official GDP growth targets that the Chinese government sets started to come under threat."

Reliable picture

Evans-Pritchard says the proxy has provided a much more reliable picture of what has happened over the past few years than the official figures have.

Discussion of this issue and what it means for Australia is timely given that China's National People's Congress meets this weekend and is expected to set a GDP growth target for 2017 not that much different to 2016.

Citi's chief China economist Li-Gang Liu confidently predicted this week that China will set a GDP growth target for this year of 6.5 per cent, down slightly from the 6.7 per cent growth achieved in 2016.

Evans-Pritchard says that those who followed the official GDP growth figures over the past few years made two mistakes.


They failed to understand that there was a sharp downturn in economic activity in China which began in mid 2013. In turn, they failed to realise that there was a sharp recovery which began in early 2016.

The paradox to emerge from these confusing signals was that those following the official bullish GDP growth figures last year ended up being too bearish in their outlook for China. At the same time Capital Economics, which relied on its proxy for growth, was telling its clients a strong recovery equivalent to the official GDP figures was under way in 2016.

Evans-Pritchard says the bears were so focused on the structural headwinds facing the Chinese economy that they overlooked the degree to which cyclical factors played a role in the recent downturn.

Slowdown imminent

He says China is now experiencing above trend GDP growth but this cannot be sustained. A slowdown is coming and its arrival will be determined by the rate of tightening in monetary policy.

China has been raising its interbank lending rates and Evans-Pritchard says more rate hikes are on the way. As well, there are signs that fiscal support will be reined in this year.

In other words China is headed for a reversal of the pick-up in economic activity in the second half of last year. Most sharemarket investors will know that the second half of last year coincided with a surge in commodity prices, particularly iron ore and coal.

China now accounts for 30 per cent of Australia's exports and yet any discussion about interest rates in Australia focuses on the relationship between our official cash rate and the actions of the US Federal Reserve.


Paul Dales, who is chief economist at Capital Economics for Australia and New Zealand, says we need to change the interest rate conversation because Australia's business cycle is now more aligned with China's than the US.

That has important implications for commodity prices and the Australian housing market.

"The coming slowdown in economic growth in China will mean the recent commodity price windfall probably won't last long,' Dales says.

"Indeed, the slowdown will mean the Chinese demand for commodities will probably fall short of expectations almost at exactly the same time as the global supply of iron ore and thermal coal increases."

This explains why Capital Economics believes the iron ore price will fall by 55 per cent this year from $US90 a tonne to $US50 a tonne by the end of the year and thermal coal will fall from $US80 to $US70 a tonne.

Against consensus

A slowing China would mean lower Chinese demand for Australia's education exports, tourism exports and property.

Dales says Chinese buyers of Australian property have not done too well in recent years in their local currency. Between May 2013 and March 2016 house prices in Australia in Australian dollars rose 25 per cent but when measured in renminbi prices actually fell relative to the previous five years.

The bottom line is that Dales and his colleagues think Australia is headed for much lower growth than expected by the consensus in the market and what has been forecast by the Reserve Bank of Australia.

Dales says he does not expect a rate hike from the RBA until 2019 or 2020 and it is possible the official cash rate will be cut this year from 1.5 per cent to 1 per cent, which would be a boon for local borrowers.