A ‘second dip’ in China GDP growth is ‘near-certain’

A surge in China’s GDP growth in the first half of 2009 has led to celebratory uncorking of champagne bottles half a world away in the expectation that China is back on its high-growth track and is leading a global economic recovery.

However, economists with a more intimate understanding of the nuances that drive China’s economy have a sobering message: a ‘second dip’ in a W-shaped economic growth outlook is coming.

“A second dip of the economy, an outlook that we have been predicting since the end of last year, will materialise with near-certainty,” says Deutsche Bank’s Greater China chief economist Jun Ma. “The stronger the short-term recovery is, the higher is the probability of the second dip.”

In particular, Ma points to the scorching 18.3% growth China registered on an annualised seasonally adjusted quarter-on-quarter basis in the second quarter of 2009 as being unsustainably high. “Any further increase in sequential GDP growth above 18% — which is 2.5 times the growth potential — can only lead to higher inflation and bigger asset bubbles — and eventually a collapse in economic growth,” cautions Ma.

In his estimation, sequential growth will taper off from 18% in Q2 this year to about 6% in Q2 next year.

The year-on-year GDP growth will peak with a lag — at 10.5% in the first quarter of 2010 — before falling to 7% in the third quarter of next year.

“We think that a further acceleration in sequential growth is virtually impossible by design of the stimulus package,” says Ma. “And even if it occurs, policies will have to respond with tightening measures.”

The ‘second dip’ will be driven mainly by a sharp deceleration in government-led fixed-asset investment growth from a high of about 60% year-on-year in the next month or two to below 10% in a year; manufacturing fixed-asset investment growth too will slow down over the same period from 30% to about 10% by mid-2010.

In fact, the ‘second dip’ will likely last longer than earlier forecast, reckons Ma. “Part of the reason is that the 4 trillion yuan stimulus package implemented over the past eight months has delayed and disrupted the corporates’ ‘de-investment’ process, when they might otherwise have slowed down capacity expansion,” he adds.

On the contrary, manufacturing fixed-asset investment growth actually accelerated in some sectors; but the second dip will reinitiate the reduction in capex.

The Chinese government will likely ‘live with’ the second dip without introducing a second stimulus package in 2010, Ma believes. In fact, he believes, the government should not go in for a second stimulus.

One reason for this is that China’s fiscal sustainability picture “is much less robust than it appears to be,” says Ma. Fiscal deficit-to-GDP ratio will likely rise to 4.5% this year, a record high barring the 1959-61 period; but that shoots up to 7-8% if bank lending that finances the budgetary portion of the government-sponsored projects is added on. Likewise, although official government debt-to-GDP is only 23%, it rises to over 40% if the data in respect of local government debt and quasi-fiscal lending by banks is factored in, reckons M.

Standard Chartered economist Stephen Green, on the other hand, estimates total government debt to be nearer to 70-80% of GDP. A large part of China’s stimulus package is bank-financed, and much of the bank financing is being informally guaranteed by local government finance bureaux, he adds. In other words, “one should probably be viewing this as an off-balance sheet liability of the government.”

China’s public finances picture, he says, “is not pretty.”