February was no exception
to the rule despite a number of positive signals recently, including a significant
increase in bank lending, easing monetary conditions and a calmer renminbi in the
wake of the G20 talks.
While February figures confirm the slowdown in Chinese manufacturing, they are generally in line with the trend over the past few quarters (see left-hand chart below. A reading below 50 indicates a contraction in economic activity, while a reading above 50 means economic activity is expanding.). And this one figure cannot reliably predict China's future growth, especially since the Chinese New Year took place during the period.
The transition of China's growth model towards service-oriented activities will not be without its bumps. The recent decline in manufacturing is justified and will last a while. The sub-components of manufacturing indicators do not point towards an upturn in manufacturing activity in the short term, but the government has fiscal and monetary tools to prevent the indicators from heading south too abruptly. The services sector is showing resilience, and this bodes well for an expansion in mass private consumption (see right-hand chart).
February's figures confirm the deceleration in Chinese manufacturing, but the real concern is to be found in the jobs sub-component. Any decline in this indicator is particularly meaningful considering the fact that a number of State-owned manufacturing groups are instructed to maintain a surplus workforce. Mass layoffs, even if justified economically by the low productivity of these State-owned groups, would make a negative impression on international investors.
If this sub-component falls, the problems may then spread from manufacturing to the services sector via the labour market. Something to watch closely in the coming months.
Soft landing or hard landing?
These two terms, which invariably arise whenever the Chinese economy is mentioned, have a quantitative aspect but a much more important subjective one. Two meanings of hard landing can be used.
- Strictly speaking, a hard landing means an economy experiences a sharp growth slowdown or even enters into recession after a period of solid growth. China, which has been losing steam since 2011, does not fit this description. An external shock such as the bankruptcy of a major industrial concern, tensions within the banking sector or a debt crisis would be sufficient to cause economic activity to contract significantly. These risks exist but are contained for now.
- More concretely, a hard landing may be diagnosed when economic growth drops below a given threshold that no longer generates – or perhaps even destroys – jobs. The ensuing social discontent can shake a country's political foundations. In China, this GDP growth threshold is estimated to be around 5.5-6%, which is below the current growth level (6.9%) and below our 2016 forecast. According to this definition, China is indeed flirting with a hard landing. And if we set aside the oft-disparaged official figures and look at indicators that give an idea of actual economic growth, this scenario is even more plausible. These latter indicators point to around 5.5% growth.
The conclusion depends, then, on the meaning of hard landing and on the figures used to assess it. We forecast a gradual slowdown in Chinese GDP growth to 6.2% by the fourth quarter of this year, which is in line with a soft-landing scenario (see chart above). The first half of the year, for example, will be affected by the curb on margin financing, a practice that took advantage of the boom in domestic equities in early 2015. But the lending boost combined with tax and monetary stimuli will partly offset the persistent surplus in manufacturing capacity.
What if this never-ending debate over a soft or hard landing was irrelevant? The Chinese government could use its massive resources to prop up growth over the coming years and ensure the economy experiences a soft landing. While appealing in the short term, the long-term cost of this approach would be steep because Beijing would only pull those growth levers it wishes to get away from: chronic overinvestment in manufacturing and infrastructures. On the other hand, a hard landing, although painful in the short term, would signal the end of past methods, sharply reduce investors' expectations and gradually bolster the services sector.
From where we sit, the Chinese government took a misstep in providing a precise numerical GDP growth target through 2020, at 6.5% per year. This figure puts pressure on the Chinese economy, offers little leeway to the government and does not ensure that services-related activities will be promoted over manufacturing and infrastructures.
This figure also seems overly ambitious compared to our forecasts, even though one can be sure that the government will use everything in its arsenal to achieve the 6.5% growth target.