FINANCIAL ICEBERG

Always consider hidden risks

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CHARTS

And now, taking into account that new economic regima that maybe taking place in China, we will take a look at what few economists say about China new trend...



China is facing like any other Asian countries in the past a huge investment boom at the beginning of their developped cycle and then see the growth rate tapering off. The investment in infrastrucuture is still huge ( near 50% of GDP ) compare to other countries but as we will see, signs of slowing are already there.

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For quite a while now we’ve been wondering whether a quite bullish forecast by Nomura’s Zhiwei Zhang and Wendy Chen will prove correct. They believe that China’s Q4 GDP growth will be 8.4 per cent — a big jump from 7.4 per cent last quarter.



We were rather sceptical when first considering it in October, because a lot of Zhang’s argument related to the local government plans that were being announced in great number in the third quarter of this year. Indeed many analysts were unsure about how much these announcements would mean — details about financing and timing were unclear with many, and some were projects that had already been announced.



Zhang and others at Nomura trawled through the various project announcements that make up the 2012 ‘stimulus’ and made the argument that even a fraction of these projects going ahead would boost growth rates. And maybe they’re right; fixed-asset investment growth definitely picked up in October. That, combined with a tentative recovery in manufacturing, could point to a stronger quarter than many expected.



However, there’s another key part of the Nomura forecasts — while they are above-consensus for Q4, they are below-consensus thereafter. The consensus is for just over 8 per cent growth in 2013.



But Nomura thinks that after this year, China’s days of 8 per cent-plus growth are finished, and that stimulus efforts will run into problems with CPI inflation, not to mention its own credit system :



​​While we are encouraged by the signals for a growth recovery in the short term, we do not expect the recovery to sustain throughout 2013. We believe potential growth in China has already slowed to 7-7.5%, and the current recovery is driven by policy easing through credit loosening, which is not sustainable. We expect rising inflation in H1 2013 as policy easing pushes growth above 8% and widens the output gap. When CPI inflation rises to above 4% – which we expect to happen in mid 2013 – policy will likely revert back to a neutral or tightening stance, allowing growth to slow toward its potential. Moreover, the current credit boom through trust loans and bond issuance will heighten financial risks in the economy. We believe the government is well aware of these risks, and will likely tighten controls on credit supply by March 2013 after the leadership transition is completed.



​In other words, the turnaround could be turning around fairly soon.



Capital Economics also believes there are adequate signs of a recovery, but their ‘China Activity Proxy’, or CAP, suggests it will be an uneven and possibly unsustainable recovery. The CAP comprises “low profile” data sets on electricity output, seaport activity, passenger journeys, freight and property activity. From Capital Economics’ Mark Williams and Qinwei Wang:

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The biggest turnaround is in electricity output, which showed the largest month over month gain since January 2011. ( See Chart 3 below ) Growth is still tepid in year over year terms but the recent acceleration is impressive, pointing to a revival in industry. ( See Chart 4 below )



• Activity at China’s seaports has also picked up over the last two months ( see Charts 5 and 6 below ), consistent with the rebound in the recent customs export data.



• The acceleration in the volume of freight being transported around the country has been less dramatic, though still encouraging since this is the broadest measure of activity in the CAP. ( See Charts 5 and 7 below )



• By contrast, the remaining two components are downbeat. The number of passenger journeys taken, a gauge of service sector activity covering both business travel and tourism, has cooled after some summer strength. ( See Chart 8 below ) This suggests that the reported strength of tourism during the National Day holiday may not have been representative of a trend to greater spending on tourism ( and services more generally ).



• Finally, we are not yet convinced that the property sector has turned the corner. Growth in real estate construction activity has increased fractionally in 3months over 3months terms but remains not much stronger than during the trough in 2009. The year over year growth rate has continued to slide. ( See Chart 9 below )



• Despite stronger property sales, inventories continue to rise as developers bring more of the backlog of stalled projects to completion. ( See Chart 10 below) This is likely to continue into next year, which will give developers little incentive to launch new projects.



Future will tell if China already started the new economic phase of less infrastrucutre investment​s in terms of GDP ; but still, China will have to shift to a consumer base economy...



A new IMF working paper lays out what many China sceptics have been saying for years: the country has too much investment, and households are bearing the costs. Yes, you might have heard this many times, but now it’s appearing in venues such as the IMF ( even if the paper warns this ‘should not be reported as representing the views of the IMF’ ).



The paper concludes that the level of over-investment is in China is equivalent to about 10 per cent of GDP , and perhaps as high as 20 per cent. The cost to households averages at about 4 per cent of GDP over the past decade, it estimates , with another 0.2 per cent to SMEs, who have higher funding costs due to the ‘two-tier’ financial system that favours large companies.

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The excess investment is mostly carried out by large companies, which are given credit on preferential terms. The costs are born by smaller companies, which have far less access to credit, and households. This, says the report, is a de facto “subsidy transfer” which is “very large”, perhaps around 4 per cent of GDP.

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One of the authors, Liu Xueyan, is a senior fellow in the Institute of Economic Research at China’s powerful National Development and Reform Commission. The paper ‘should not be reported as representing’ the NDRC’s views, either — yet it is another indication that China’s economic imbalance and the cost of correcting it are familiar topics to the country’s leaders*.

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The IMF working paper, which doesn’t necessarily represent the Fund’s views, says that Asian countries have often managed to a achieve high investment rates, usually by resorting to foreign finance. This typically “eventually led to banking of foreign exchange crisis, from which it took them several years to recover”.



China doesn’t face a similar threat, because of its financial self-reliance. But the report warns of “concerns about the underlying domestic strain associated with financing such a high level of investment, which appears to be implicitly borne by households.”



In other words, though the report is too polite to say so, watch out for social protest.



China has long invested more of its output than other Asian countries but it accelerated investment between 2007 and 2011 to nearly 50 per cent of GDP to counter the impact of the global crisis, said the report.

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So, the paper says that over-investment is equivalent to 10 per cent of GDP, but it costs about 4 per cent of potential GDP.



That maths is pretty clear: rebalancing will inevitably require lower growth . The paper’s authors acknowledge it, too:



To the extent that elevated levels of investment during the post-crisis period in China were somehow abnormal and necessitated by the sharp external slowdown, the challenge now is how to return to a more “normal” level of investment without compromising growth and macroeconomic stability.



Finally, this observation from the paper’s literature review says a lot about why this imbalance issue has taken a while to bubble up into the mainstream:



Much of the literature imposes a number of strong assumptions and few papers compare China’s investment to that in the rest of the world. A variety of approaches taking to account for the plethora of potential factors that may be at play in determining investment trends in China. These factors include China’s low initial capital endowment, its level of development, and favorable returns to capital. However, most of this work is based on calculations of investment efficiency that are assumption-based and prone to measurement error. In addition, many have adopted an indigenous approach focusing on China alone, with fewer attempts to use cross-country data to compare its investment trends against those of other economies. Other common limitations include relatively unrepresentative samples, short time periods, and the relative paucity of studies covering the post-2005 further surge in investment.



As we’ve been saying for a long time around here, assumptions about China are rampant, from the urbanisation myth to the belief that it will continue to grow above 8 per cent, that it should, and that the rest of the world even needs it.The report concludes:





While a crisis appears unlikely when assessed against dependency on external funding, potential strains from financing high investment still exists and could be quite large. Assuming the conditions that prevailed in other emerging market economies during their pre- and post-crisis periods also apply to China, the probability of a crisis in China would mechanically be about one in five. However, because of the differences in the modality of financing of investment, an external crisis of the kind experienced by many other emerging market economies appears very unlikely to occur in China. But this does not mean that the cost is also absent. Rather, it is distributed to other sectors of the economy in the form of a hidden and implicit transfer of resources. In China, a large burden of the financing of over-investment is borne by households, estimated at close to 4 percent of GDP per year, while SMEs are paying a higher price of capital because of the funding priority given to larger corporations.



The only answer, says the Fund, is to bring down investment over time. Easier said than done, of course, as Beijing has already discovered in efforts to boost consumption.



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​​ Is China Over-Investing and Does it Matter?

China s Economy - weaker than we think

​ ( From Macro Business, AsloSprachAnalyst )



China is facing like any other Asian countries in the past a huge investment boom at the beginning of their developped cycle and then see the growth rate tapering off. The investment in infrastrucuture is still huge ( near 50% of GDP ) compare to other countries but as we will see, signs of slowing are already there ( see graph below ). As the graph shows, compare to other Asian s countries growth cycle, the Gross Capiatl Formation, or investment in infrastrucutre will slow down...



When infrastrucutre are built too quickly to generate economic growth in China, the result can be surprising ( from mail online ) :



​​ A lone apartment building stands in the middle of a newly built road after an elderly couple refused to relocate.



Luo Baogen and his wife insist on living in the half-demolished building in the city of Wenling, in Zhejiang province, China because they believe that the relocation compensation offered by the government is not enough.



Now the only building left standing, the five storey block is a strange sight as cars drive around it while the couple remain living inside.





