China Q3 GDP roars, but growth quality ‘stinks’

China’s economic engine, boosted by government-injected stimulus steroids, roared to 8.9% in the third quarter of 2009, from 7.9% in the second quarter, but economists were divided on whether the turbo-charged growth momentum was healthy and sustainable.

The government looks set to meet and perhaps exceed its 8% growth target for the full year, but “we find it hard to share in the general euphoria about China’s economic prospects because the structure of growth stinks,” notes Arthur Kroeber, Beijing-based managing director of Dragonomics Research.

In particular, Kroeber points to nominal GDP, which grew by only 4.7% in the first nine months, “which is a bit better than in the first half, but still incredibly slow.”

In effect, around 40% of “real growth” is still generated by price declines, and investment accounted for 95% of growth in the first three quarters. “Consumption contribution remains at historically low levels and much of it is coming from the government, not the private sector,” says Kroeber.

RBS economist Ben Simpfendorfer revised his 2009 GDP projection upwards from 8% to 8.5%, but also noted that the “focus will now shift to growth imbalances and inflation worries.”

The biggest challenge for Chinese authorities, he says, “is that the private sector has yet to fully recover. This makes it difficult to tighten early. It also funnels money into equity and housing rather than the real economy.” The temptation, he reckons, will be to leave policy too loose for too long, resulting in another asset price bubble.

Others, however, see more positive signs in the latest GDP data. “We think a full and better balanced recovery is well on track,” says Credit Suisse economist Dong Tao, who too revised his GDP projection for 2009 from 8% to 8.4% and for 2010 from 9% to 9.3%.

“Housing activities have accelerated (in Q3), while government-sponsored infrastructure investments have shown signs of moderation,” says Tao. “With exports showing signs of a faster recovery in September, we think the base for a recovery is broadening.”
JP Morgan chairman of China equities Jing Ulrich too sees evidence that “China’s economic recovery is broadening.”

Looking ahead to the fourth quarter and to 2010, Ulrich believes that the drivers of China’s economic growth will “shift from stimulus-driven infrastructure projects to private investment and the recovery in exports… Signs of this shift are already being seen in the sharp recovery in housing construction since this summer and a major narrowing of the export decline in September.”

China’s fiscal stimulus and loose monetary policy “have proven remarkably effective,” says Ulrich. And having stabilised the domestic economy, authorities are “increasingly turning their attention to improving the quality of growth,” she said, pointing to measures introduced to curb expansion in industries that are prone to overcapacity, increase support for small and medium-sized businesses, and nurture development in social welfare and environmental protection. 

Kroeber, however, believes that the financial risk from excessive lending is now spreading beyond the banking system. “Despite inflationary concerns, some officials have indicated that new bank lending - which will more than double in 2009 to 10 trillion yuan - will remain at 8 trillion yuan in 2010, still well above the long-term trend,” he points out. “In order to have balance-sheet room for all these new loans while still meeting prudential ratios, banks are selling packages of loans to finance companies controlled by big state-owned enterprises.”

In other words, he says, “financial risk is being spread well beyond the banks… There will need to be one almighty clean-up in a few years’ time.”