Weekly commentary from Wells Fargo Investment Institute on international topics in the news.
Peter Donisanu, Investment Strategy Analyst
What to Make of China’s Economic Growth?
- China surprised once again with a better-than-expected gross domestic product (GDP) growth rate in the first quarter of 2017.
- While growth in China’s economy accelerated during the first three months of the year, we expect the pace of economic expansion to ease throughout the rest of 2017.
What it may mean for investors
- Stabilization in China’s economy and a rebound in international trade nonetheless continue to support our favorable view of equities in the Emerging Markets (EM) Asia region.
On Sunday, April 16, China’s National Bureau of Statistics reported that the country’s economy expanded at a rate of 6.9 percent on a year-over-year basis during the first quarter. This figure reflects two quarters of reacceleration after the economy grew at a rate of 6.7 percent and 6.8 percent in the third and fourth quarters of 2016, respectively. Some investors have asked whether this recent growth development is likely to be the start of a new upward trend in China’s economy. We believe that the phenomenon of reaccelerating growth is likely transitory, and we expect the speed of China’s economic growth to slow throughout the rest of this year.
The pace of growth in China’s economy has been in a steady decline since early 2010 (Chart 1). In the prior decade, a combination of booming construction and manufacturing activity had pushed growth up to 15 percent. A maturing economy and weaker demand in these sectors has led to a lower rate of growth. Today, China’s economy suffers from overcapacity in the construction and manufacturing sectors. In recent years, leadership in Beijing has voiced a desire to transition China toward a services-oriented economy with less reliance on these two sectors as drivers of growth. As a result, addressing areas of overcapacity has led (and likely will continue to lead) to a slower rate of growth in China’s economy.
One of Beijing’s key concerns during this economic transition, however, has been how Chinese leaders can prevent growth from slowing too fast, too soon (a hard landing). A confluence of negative events in 2015 and 2016 prompted some financial-market participants to speculate that the country’s economy was headed for such a hard landing. The government intervened to support the economy by making credit more attainable, increasing government expenditures and introducing other policies to incentivize household spending. Consequently, recent data has shown that the pace of declining growth eased in 2016 and that economic growth reaccelerated in the six-month period ending in March of this year.
China’s ongoing need to address structural imbalances and the utilization of artificial measures (credit and government spending) to support the economy suggest to us that the recent rebound in growth is likely to be short-lived. Indeed, recently-released data indicates that growth in government spending (Chart 2, left clip) and credit creation (Chart 2, right clip) has slowed over the past six months. We expect this deceleration in credit and spending to contribute to slower economic-growth rates in the coming quarters. With that said, we believe that the actions taken by Beijing in 2015 demonstrate a willingness to ensure that any slowdown in growth occurs at a stable, measured pace.
From an investment perspective, this week’s surprise GDP print further confirms our view that growth in China’s economy has stabilized for the near term. We believe that this should be supportive of financial-market sentiment in the region. Further, we believe that Beijing’s commitment to avoiding an economic hard landing should provide a boost to market sentiment. For emerging-market equities, our favorable rating on the EM Asia region has been underpinned by generally improving global economic conditions, which we partly attribute to China’s stabilization. Additionally, a recent rebound in international trade suggests that trade-sensitive markets in the region (South Korea, Malaysia and Thailand) also should benefit from a stronger global (and Chinese) economy this year.
A key risk to this view comes from a sudden China-related shock to international trade and global economic growth.1 Yet, we view this risk as limited in the near term. The government’s implicit support to backstop the country’s from a hard landing, coupled with Beijing’s target growth rate of around 6.5 percent this year, suggests that slower Chinese economic expansion has been planned and likely is manageable. For now, we expect that the surprise growth figure for the first quarter to likely to be transient, and we believe that investors should anticipate future GDP reports to show marginally slower growth this year.
1 For more information on potential China-related shocks, please see our reports:
International Briefing: “China’s Bank Debt Problem is Real, Likely Manageable"; February 26, 2016.
International Briefing: “Game Over for China?”; March 4, 2016.
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