Much as we expected, China’s economy has continued to slow faster than consensus, but does not appear to be in a hard landing. We expect it to achieve a 6.7% HoH SAAR growth rate (equating to 6.8% YoY) in the 4Q14-1Q15, although this is below consensus of 7.3% (of course, China can announce almost any number it wants due to the lack of transparency and questionable quality of its statistics).
Inflation remains tame, as measured by the CPI, and pipeline inflation remains negative. Exports have rebounded a bit recently, while imports in value terms are suppressed mostly by lower commodity prices (but the Korean data described on p.1 are also important to consider). Housing starts are declining rapidly, but the backlog of orders should support the economy, at least through this year (although next year is likely to be negative). Auto sales, on the other hand, remain quite firm and it will be crucial to watch this trend going forward.
Despite much pain caused, the government continues its pressure to reform its economy, as it believes imbalances must be corrected and as it tries to shift to a modern economy. It also wants to centralize power and reduce local corruption and autonomy. Credit defaults are increasingly commonplace now, with many firms found to have over-pledged collateral. The wealth management business of large banks remains strong, but the trust industry is struggling due to defaults and high investor risk aversion, which is greatly reducing credit to risky borrowers.
We still believe that the country’s large hidden bad debts have yet to be fully disclosed and that China’s real estate market is overpriced, with property price declines now quite widespread. We are not much comforted by the oft-stated supposition that debt is not officially used to a large degree for residential purchases (although there is more than USD1TT of official mortgages), as this was true for Japan in the late 1980s, as well, and did not stop price declines. We also forecast that a significant amount of unofficial borrowing is behind many apartment purchases and that many companies, in a wide array of industries, have improperly speculated in the market and will be flushed out by the current reforms. Indeed, there are large speculative holdings of vacant apartments, which will be severely tested as prices decline. The wealth effect of such declines is negative, but so far there are no signs of panic and we expect continued government reforms to begin to excite foreign equity investors in the coming quarters.
Lastly, industrial production will continue to be constrained so as to reduce pollution and we continue to expect (as we have for several years) that huge efforts will be made, even beyond current optimistic projections, on solving this problem, which will provide many good investment opportunities for global providers of pollution control equipment of all kinds.