Chart of the week – Premier Li’s drive for stability means ‘doubling down’ will continue in China

Early last year we raised the prospect of China throwing in the towel on reform and rebalancing. By April, with the authorities still struggling to rebalance and economic growth well below the desired level, we felt that a change of course was imminent and the idea that China would ‘double down’ became our central scenario. As if on cue, indicators associated with China’s old growth model – such as the growth in investment by state-owned enterprises – picked up, and our China Momentum Indicator (CMI) bottomed out.

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Our China Momentum Indicator (CMI) combines rail freight volumes, electricity production and nominal bank lending; all three of which were identified by Premier Li Keqiang as providing a better gauge of economic activity than the official estimate of GDP.

In February our CMI stood at 3.3%, marking the thirteenth consecutive month that it has risen.  At the National People’s Congress, Premier Li said “stability is of overriding importance”. Given this, we expect the CMI to continue to pick up, as policymakers rely on the old growth model to drive the economy.

But this strategy is putting even more fire under the cauldron of bad debt, and inflating the credit bubble even further. The creation of ghost towns, in which residential properties are unsold, public spaces unused and shops unleased, provides a stark reminder of why a growing proportion of investments are struggling to service the debt from which they were built.

Our own calculation suggests that China’s non-performing loans now amount to around 30% of official GDP. That ratio is set to rise, with China getting less and less bang for its buck as credit is disbursed in haste to increasingly ill-conceived projects. The long-run implication of this is, at best, Japanification of China: delivery into a much lower growth and yield environment, permanently. But in the short term, it delivers a much-needed, if temporary, boost to growth.