China GDP preview: Q3 was a tough quarter

China’s Q3 growth figures are due out next Tuesday and are expected to highlight how tough the quarter was for the world’s second largest economy. The economy is expected to have expanded around 7.2% y/y, after a 7.5% growth rate in Q2, and 7.4% YTD y/y. This is clearly below the government’s official growth target of 7.5%, although Beijing has stated recently that it would accept growth slightly below this level.

The problem in China is that most economic data has significantly softened since Q2, raising concerns about the health of domestic demand and the property market. The biggest piece of potentially positive economic data came from the export sector, with exports jumping an impressive 15.3% y/y in September, but even this isn’t doing much to calm investors’ nerves. The authenticity of the aforementioned trade data has been brought into question due to the likelihood of more fake invoicing by exporters.

China’s problems

Looking at the graphs below you can see the full extent of the problem. Figure one shows us that GDP has been slowly softening for a while, but at least it doesn’t come as a surprise to the market, or Beijing for that matter. Consumer prices however aren’t performing as expected. The stagnant, and now falling inflation rate raises a lot of alarm bells, namely because it reiterates the lack of domestic demand and confidence that is highlighted in other economic data.

This brings us to figure 2, which shows a significant drop in retail sales growth and deteriorating activity at the heart of China’s economy. The lack of activity at the ground level is going to complicate Beijing’s attempts to transition the economy into one that is more focused on domestic demand as it weighs on the exact areas that the government is looking to for long-term growth.

Figure 1

Source: FOREX.com

Furthermore, the biggest threat to China’s economy comes from within the property market. Last quarter we watched as more and more cities – including tier one cities – experienced falling property prices (see figure 3), which forced the relaxation of property curbs and even prompted some stimulus from Beijing.

Figure 3

Source: FOREX.com

Why are falling property prices a problem for China?

Construction and real estate sectors account for around 15% of GDP and are the backbone of many other parts of the economy. To put the size of the market in perspective, China produced more cement in 2011 and 2012 than the US did last century. Domestically, mortgage loans led a massive surge in credit growth in the last 5/6 years and 90% of the urban population own at least one house.

Can Beijing help?

The reason why the market isn’t as concerned about the aforementioned deterioration of the economy as it otherwise would be, is due to the policy tools available to Beijing in order to manage the economy. Thus far, Beijing has relaxed property curbs, boosted liquidity through direct cash injections, target funding to smaller companies through reverse repos and other measures.

However, more may be needed to be done. Beijing is faced with a huge policy dilemma – it wants to support sustainable and healthy economic growth by it’s also attempting to make hard structural changes and steer the economy away from its reliance on unhealthy growth. The former denotes more monetary easing, while the latter requires a tightening of credit markets to starve some off-balance sheet lending.

How is AUD going to react to China’s GDP figures?

The Australian dollar can react very interestingly to Chinese economic data. It can go either way if data is worse than expected, or better than expected for that matter. Sometimes the market takes worse than expected data to mean that Beijing will ease policy further, which is AUD positive. Other times, investors take Chinese economic data at face value. The reverse is true for better than expected economic numbers.

This time around we think the AUD may rally if Tuesday’s GDP figures are worse than expected as it may prompt more stimulus from Beijing, which has the scope to ease policy further at this stage (it may even see the PBOC cut the RRR). In the event of mildly better than expected data, we may only see a slight reaction from the aussie, but we think this also may be to the upside, although that is purely speculation.