China: August data suggests a more severe slowdown

The August data released this weekend was markedly weaker than expected and suggests the loss of momentum in growth could be more severe than expected (see below for details). Particularly weak industrial production suggests that GDP growth could drop below 7% y/y in Q3 from 7.5% y/y in Q2. That said, China’s manufacturing PMIs remained above 50 in August and have so far only indicated a moderate slowdown. Hence, it is possible that anomalies could be behind weak industrial production data in August.

There is little doubt that the recent loss of momentum in China has been driven entirely by weaker domestic investment demand (see below for more details). In addition, it appears the slowdown in investment demand appears to have become more widespread in August. Housing investments remain weak, but investments within manufacturing and transportation have also started to weaken albeit less dramatically. On a positive note, retail sales and the foreign trade data released last week suggest private consumption and exports remain relatively resilient. Hence, so far no signs of a substantially negative spill over to private consumption from the weak property market.

In our view, there are three main explanations for the current weakness in investment demand: 1) slower credit growth particularly in some sources of shadow finance, 2) a possible negative impact from the anti-corruption campaign that appears to have accelerated again during the summer; some anecdotal evidence that the corruption campaign has started to impede investment decisions, 3) the impact from the spring minifiscal stimulus has started to wane. The weak economic data for August suggest that there is again increasing risk that the government will miss its 7.5% growth target for 2014. Last week, Premier Li Keqiang sounded relatively defiant in his speech at the Summer Davos meeting, where Li said that “..in July and August indicators fluctuated somewhat” and the government would “…refrain from being distracted by slight short-term fluctuations of individual indicators.” Li would probably have known the weak numbers ahead of his speech, so this does not suggest any imminent easing from the government.

Nonetheless China has, in our view, moved closer to renewed easing despite Li’s defiant tone and the August hard data possibly exaggerating the severity of the slowdown. In our view, there will be renewed easing if the slowdown is confirmed in the manufacturing PMIs and they decline below 48 in the coming months. A cut in the leading interest rates is now a possibility, although Peoples Bank of China (PBoC) has been reluctant to use this instrument. Obviously, the Chinese government does not want another credit boom and for that reason will only ease cautiously. However, the Chinese economy has also reached the stage where the Chinese government will start to undershoot even on some f its monetary and credit targets: 1) Money supply growth in July eased to 12.8% y/y (target is 13.0% y/y in 2013). 2) Underlying total credit growth slowed to 10% annualised in the past three months, according to our calculations, fmeaning that credit growth is now broadly in line with nominal GDP growth (no official target for credit growth). 3) Inflation declined to 2.0% y/y in August and could decline further in coming months (“Target” for inflation in 2014 is 3.5% y/y). 4) Increasing risk it will undershoot its 7.5% GDP growth target for 2014. Room to ease should limit downside risk. If the slowdown proves more severe, there also will be increasing risk that China will again intervene in the FX market to stem the appreciation of CNY. However, the trade balance surplus has surged in recent months on the back of resilient exports, weak domestic demand and lower commodity prices. Hence, fundamentals still suggest moderate appreciation of CNY.

Details

Industrial production in August eased markedly to 6.9% y/y (consensus: 8.8% y/y, Danske: 8.8% y/y) from 9.0% y/y in July. This is the lowest year-on-year increase in industrial production since December 2008. Seasonal adjusted industrial production in August declined 0.1% m/m after increasing 0.7% m/m in July. However, industrial production and the manufacturing PMIs give very different signals on the severity of the current slowdown (see chart below). The weak industrial production in August would be consistent with manufacturing PMIs below 45. Both China’s manufacturing PMIs were above 50 in August. This suggests that there could be some anomalies in the data and we should be careful to draw conclusions solely on the weak hard data for August.

Nonetheless, industrial production is an important input in the GDP calculation and usually is the best indicator for estimating GDP growth. If the weak 6.9% y/y growth in industrial production in August is taken at face value, it suggests that underlying GDP growth is now just 6.2% y/y (see chart below). Even if growth in industrial production rebounds to 9.0% y/y in September, our model for GDP growth based on production indicates that GDP growth will slow markedly to 6.9% y/y in Q3 from 7.5% y/y in Q2 (Our current forecast only assumes moderate slowdown to 7.4%.) Hence, there is obviously downside risk to our GDP.

Fixed asset investment (FIA) in August eased to 16.5% YTD y/y (consensus: 16.9% YTD y/y) from 17.0% YTD, y/y in July. According to our calculations, growth in fixed asset investments in August eased to 13.3% y/y from 15.6% y/y in July and 17.8% y/y in June. Hence, seasonal adjusted FAI according to our calculations only increased 0.3% m/m in August after increasing 0.9% m/m and 0.6% m/m in July and June, respectively. In other words, growth in fixed asset investment has just been 7.1% annualised in the past three months. Bottom line: FAI growth appears to have slowed markedly in recent months.

Looking into the details, the weakness in investment demand has become more widespread in August with investment within manufacturing and transportation also starting to weaken. Previously, weakness in investment demand has mainly been concentrated within property (see charts below). That said, the signals within the housing market have become a bit more mixed in recent months. Housing starts have actually started to recover slightly in recent months, but sales of new homes remained weak, albeit rebounding slightly in August on the back of a large decline in July. New home sales tend to lead housing starts and house prices, so we need to see stabilisation in new home sales before we can call the bottom on the property market.

Retail sales in August eased to 11.9% y/y (consensus: 12.1% y/y, Danske: 11.9% y/y) from 12.2% y/y in July. With CPI inflation in August easing to 2.0% y/y from 2.3% y/y July, this means that real growth in retail sales has been basically stable. Seasonal adjusted retail sales increased 0.8% m/m in August after increasing 0.9% m/m and 1.0% m/m in the July and June according to our calculations. This means that growth in retail sales has been 11.3% annualised in the past three months and hence is now growing faster than fixed asset investment ( 7% annualised in the past three months).