Nomura: China recovery unsustainable

Cross-posted from FT Alphaville.

For quite a while now we’ve been wondering whether a quite bullish forecast by Nomura’s Zhiwei Zhang and Wendy Chen will prove correct. They believe that China’s Q4 GDP growth will be 8.4 per cent — a big jump from 7.4 per cent last quarter. Not surprisingly, today’s flash PMI has made Zhang more confident in his forecast.

We were rather sceptical when first considering it in October, because a lot of Zhang’s argument related to the local government plans that were being announced in great number in the third quarter of this year. Indeed many analysts were unsure about how much these announcements would mean — details about financing and timing were unclear with many, and some were projects that had already been announced.

Zhang and others at Nomura trawled through the various project announcements that make up the 2012 ‘stimulus’ and made the argument that even a fraction of these projects going ahead would boost growth rates. And maybe they’re right; fixed-asset investment growth definitely picked up in October. That, combined with a tentative recovery in manufacturing, could point to a stronger quarter than many expected.

However, there’s another key part of the Nomura forecasts — while they are above-consensus for Q4, they are below-consensus thereafter. The consensus is for just over 8 per cent growth in 2013.

But Nomura thinks that after this year, China’s days of 8 per cent-plus growth are finished, and that stimulus efforts will run into problems with CPI inflation, not to mention its own credit system (our emphasis):

While we are encouraged by the signals for a growth recovery in the short term, we do not expect the recovery to sustain throughout 2013. We believe potential growth in China has already slowed to 7-7.5%, and the current recovery is driven by policy easing through credit loosening, which is not sustainable. We expect rising inflation in H1 2013 as policy easing pushes growth above 8% and widens the output gap. When CPI inflation rises to above 4% – which we expect to happen in mid 2013 – policy will likely revert back to a neutral or tightening stance, allowing growth to slow toward its potential. Moreover, the current credit boom through trust loans and bond issuance will heighten financial risks in the economy. We believe the government is well aware of these risks, and will likely tighten controls on credit supply by March 2013 after the leadership transition is completed.

In other words, the turnaround could be turning around fairly soon.

Capital Economics also believes there are adequate signs of a recovery, but their ‘China Activity Proxy’, or CAP, suggests it will be an uneven and possibly unsustainable recovery. The CAP comprises “low profile” data sets on electricity output, seaport activity, passenger journeys, freight and property activity. From Capital Economics’ Mark Williams and Qinwei Wang:

The biggest turnaround is in electricity output, which showed the largest m/m gain since January 2011. (See Chart 3.) Growth is still tepid in y/y terms but the recent acceleration is impressive, pointing to a revival in industry. (See Chart 4.)

• Activity at China’s seaports has also picked up over the last two months (see Charts 5 and 6), consistent with the rebound in the recent customs export data.

• The acceleration in the volume of freight being transported around the country has been less dramatic, though still encouraging since this is the broadest measure of activity in the CAP. (See Charts 5 and 7.)

• By contrast, the remaining two components are downbeat. The number of passenger journeys taken, a gauge of service sector activity covering both business travel and tourism, has cooled after some summer strength. (See Chart 8.) This suggests that the reported strength of tourism during the National Day holiday may not have been representative of a trend to greater spending on tourism (and services more generally).

• Finally, we are not yet convinced that the property sector has turned the corner. Growth in real estate construction activity has increased fractionally in 3m/3m terms but remains not much stronger than during the trough in 2009. The y/y growth rate has continued to slide. (See Chart 9.)

• Despite stronger property sales, inventories continue to rise as developers bring more of the backlog of stalled projects to completion. (See Chart 10.) This is likely to continue into next year, which will give developers little incentive to launch new projects.

Overall, write Williams and Wang, their CAP measure does support the view that a recovery of sorts is underway… but they’re also not convinced it will last:

However, it would be unwise to count on continued export strength and, with the outlook for property construction activity still shaky, we expect China’s rebound to remain subdued.