China’s GDP figures for the second quarter show that economic activity is levelling off at 6.7%, the same as last quarter. They are also a reminder of the government’s focus on the construction sector (+7.3%) and property market (+8.8%) in its stimulus programme. Growth in financial services was weaker (+5.3%), but this was not a surprise, as financial intermediation returned to earth after being buoyed by the soaring stock market in the first half of 2015.
We believe that the Chinese economy is headed for a soft landing this year. These quarterly figures back our view, even though they are slightly ahead of our projections. The difference stems from the government’s support for the property market and infrastructure spending. We have adapted by raising our full-year growth forecast from 6.4% to 6.5%.
All in all, these results are good news for investors and for the Chinese economy. Yet they also show that the government's extensive stimulus measures have only had a limited impact. Ongoing production overcapacity is probably discouraging spending by private companies, with the massive injection of credit translating into less and less capital spending.
This situation, which is also linked to bad debt in the Chinese banking system, will have to be addressed by structural reforms sooner or later. The government’s readiness to let state-owned manufacturers default on their payments shows that its financial support is neither unlimited nor unconditional. But a coherent action plan will be needed to help state-owned companies figure out how to turn a profit.
In the next few months, the government is likely to scale back its stimulus programme. Financial services have shored up since early 2015, and this should help offset a likely correction in the property market following the recent flare-up in prices that sparked a response from the government. With the debt component of the government’s stimulus effort losing its punch, 2017 promises to be a turbulent year, and the official growth target of 6.5% is rather ambitious.
The growth outlook among emerging markets has improved in recent weeks. The rise in commodity prices has boosted major exporting countries, growth in China is stabilising, and global liquidity is abundant and set to remain so. But emerging markets are headed towards a period of economic stabilisation rather than a real jump in growth. Economic activity is being held in check by problems at the domestic level, such as a continued decline in productivity, weak trade among emerging-market countries and excessive debt levels.
This is not the kind of environment in which emerging-market shares are likely to outperform. On the other hand, the major central banks in developed countries are keen on further monetary expansion, which implies low interest rates and plentiful liquidity. This reflationary policy, together with the increasingly firm growth outlook among emerging markets and a pullback in investors’ risk aversion, bodes well for emerging-market bonds.
EM bonds also compare favourably to their developed-market brethren in terms of compensating risk. They now offer a viable alternative to the low yields seen in developed countries, where negative interest rates are becoming more common.