Based on official data, China appears to have started off 2024 on the right foot, with the pick-up in several indicators (including industrial production, retail sales and exports) implying that the economy is improving. Indeed, China’s National Bureau of Statistics released a robust first quarter GDP growth rate of 1.6% quarter-on-quarter, up from the previous 1.2%. Year-on-year, the growth figure was a notable 5.3%. This release surprised on the upside, prompting widespread upward revisions to the forecast growth rate for the year, including those surveyed by Reuters Polls. Interestingly, however, Fathom’s China Momentum Indicator (CMI) paints a rather different picture: with it returning a quarterly GDP growth rate of 0.9% in Q1, which is not particularly bad but most definitely less rosy than implied by China’s official data.
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The first quarter of the year is the most important one to explain the full year GDP growth figure. This is because the first quarter establishes a higher starting point from which all subsequent changes within that year are measured. Therefore, if one aims to overstate the annual GDP growth rate, the best moment to do it would undoubtedly be in Q1. On reflection, we have found evidence that this may have been the case in China over the past years, as shown by greater upside surprises in that quarter relative to others when compared to the Reuters Poll of economic forecasts.
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It comes as no surprise that economic growth, according to our CMI, looks to be slowing. Indeed, authorities still remain hesitant when implementing significant fiscal stimulus measures, as shown by the underwhelming progress of the rollout of local government special purpose bond issuance for this year (only 30% of the yearly quota has been filled up to May 2024, compared to 50% for the past two years), as well as the relative tightening of the cyclically-adjusted fiscal balance run by the government, according to Fathom’s calculations.
Meanwhile, on the monetary front, the People’s Bank of China (PBoC) has implemented RRR and policy rate cuts. However, the low inflation environment that the economy is currently experiencing has offset them, resulting in a rise in real interest rates. In other words, there has been real monetary policy tightening, resulting in rising financing costs for consumers and firms.
All together, policy conditions have become less slack over the past year (but still loose relative to other historical periods) according to Fathom’s proprietary China Policy Gauge. Our gauge assesses overall policy conditions in China using a broad range of variables to derive the current stance of both monetary and fiscal policy.
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Nevertheless, behind the scenes, Chinese authorities have been acting to negate some of the disequilibria accumulated within the economy. One example is the rise in non-performing loans (NPLs), which is a consequence of years of ill-judged investment in housing and other sectors.
Notably, official estimates of China’s NPLs suggest that they were a meagre 2.5% of GDP at end-2023. However, Fathom’s proprietary measure indicates that the true number is much greater, somewhere in the range of 37% and 50% of GDP. This range reflects the fact that the authorities may have taken additional steps to reduce the stock of bad loans, by encouraging write-offs that are not fully captured in the official disposal of NPLs data.
Evidence for these additional write-offs can be found in the PBoC’s balance sheet, whose stock of assets held against financial and other depository corporations has risen sharply, by RMB 13 trillion between 2016 and 2023. If this reflects lending that is done to encourage banks to purchase NPLs, with an implicit understanding that the PBoC will not demand repayment should that borrower default, then that is equivalent to writing off the NPLs.
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If we are viewing the expansion of the PBoCs balance sheet correctly, then this strategy has led to total NPLs as a per cent of GDP in 2023 falling for the first time since 2016. Going forward, we expect this picture to continue, with authorities implementing a strategy of ‘extend and pretend’ — writing off loans gradually in a bid to avoid a banking crisis. This has been China’s tactic to date, and it will continue to weigh on an already slowing economy as it negatively impacts banks’ balance sheets for longer while tying up resources in unproductive assets.
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Other signs of intervention can be seen in the FX market. The renminbi has been under pressure over the past couple of years, mainly due to interest rate differentials with the US as the Fed started its hiking cycle. While a weaker RMB is a tailwind for export demand, as the price of goods becomes relatively more competitive in international markets, it also risks exacerbating capital outflows. In this context, the PBoC has been trying to stabilise the currency, as shown by the significant divergence between the spot rate and the central parity rate set by the central bank.
It is indicated that this has been achieved via indirect intervention through the big state banks, which have been instructed by government authorities to sell foreign currency. This new currency playbook sits in contrast with the usual modus operandi of central banks using their foreign exchange reserves. Interestingly, official data for PBoC foreign exchange reserves does not show a significant change during this period.
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Arguably, these measures (writing off NPLs, exchange rate intervention, etc.) are a continuation of China’s old playbook. However, the country now faces a new reality: the housing market is a drag on growth. In this context, China needs to find a new model of growth and, judging by the data, it seems like the country will focus its efforts on expanding what has been named the ‘new pillars of growth’ — lithium batteries, EVs and solar panels — among other things.
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However, the success of these strategies is also dependent on other countries. Not only will China be looking to them as export destinations, but also for know-how. For that reason, China will be keen to avoid the US and its allies imposing additional trade restrictions as they de-risk. But how? One theory that Fathom has been exploring is whether China is using a ‘Broken Wing’ tactic. This consists of advertising its economic weaknesses where they exist: if the US and allies believe that China has passed its peak, there is no need to de-risk, since China cannot pose a serious threat to US hegemony. This would allow China to retain access to the tech innovation that eventually may allow them to overtake the US as the world’s richest economy.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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