China Continues Its Shift Toward Services 

Author: Alex Frew McMillan

Posted on: The Street Real Money, April 17th, 2017




Maybe China isn’t making the economic sucking sound that we expect.

China’s gross domestic product came in at 6.9% for the first quarter of 2017, the country’s National Bureau of Statistics reported on Monday. That’s an unexpectedly strong showing, stronger than even the all-powerful Communist Party anticipated. It suggests the economic slowdown may not be occurring as advertised.

One of the main drivers of the strong 1Q was a high level of investment, follow-through from the boom in real estate purchases and prices in China’s biggest cities. Service-sector growth ran at close to 8%, and now accounts for more than half the Chinese economy, exploding the myth that it’s all about exports when it comes to the Middle Kingdom.

It didn’t hurt that stronger external demand did mean shipments out of China increased. But the rebalancing that the Beijing government is trying to encourage, away from manufacturing and toward the service sector, appears to be happening.

Retail sales for March popped 10.9%. Consumption, something the government desperately wants to spur, accounted for 77.2% of the first-quarter growth. That was despite sluggish auto sales, as a tax break on car purchases expired.

I’m sitting across the border here in Hong Kong, and my take on it is that China is in pretty solid shape. The same couldn’t be said at the start of last year, when there was widespread pessimism.

In 2017, there has been a mild pickup in the number of visitors here coming from the mainland, and I see and hear it in the streets. At one point soon after the Occupy Central “umbrella movement” pro-democracy protests in late 2014, the mainlanders stopped coming. But they’re back, and they’re shopping.

The 6.9% growth for the first three months of the year was the fastest rate of growth since the third quarter of 2015. The first three months of 2017 also marked the first time in seven years that there had been two straight quarters of faster growth.

Economists were surprised. Growth came in at 6.8% in the last quarter of 2016, up from the 6.7% rate posted in the first nine months of the year. Forecasts suggested it would maintain that pace. So the outperformance for 1Q is significant for its direction, even if its magnitude is slight.

There was widespread doom at the start of 2016 that China might well experience a hard landing. With that averted, most economists anticipated slowing but still strong growth. Now it seems the slowing growth isn’t even happening as planned.

China’s central government has ordered … excuse me, “forecast” … growth to slow to around the 6.5% level in 2017, down from 6.7% for 2016. Some prognosticators, Oxford Economics among them, don’t expect it even to hit the government’s desired rate – the group pegs growth for this year at 6.3%.

After the 1Q outperformance, there now are voices suggesting that the economy may continue its positive surprises in the near future. The “upbeat data for March suggests that some of this strength will likely extend into the second quarter,” Julian Evans-Pritchard, the China economist at Capital Economics, wrote in a note.

But Evans-Pritchard isn’t too sure how long the upside surprises will last beyond that. Growth in credit drove much of China’s recent recovery, and that trend has reversed. China will “begin slowing before long,” he concludes.

The Communist Party holds its 19th National Congress this fall, a key meeting that sets the agenda for the next five years. There will be plenty of jockeying for position behind the scenes as the seats on the Politburo Standing Committee, the seven-person equivalent of a cabinet, are allocated.

The politicking likely saps some of the demand for a strong push for the structural reform of China’s bloated state-owned enterprises. The key for the party now is to maintain stability, and the strong numbers also encourage a bit more frugality from the central People’s Bank of China.

Commerzbank still expects China to produce 6.5% growth over the course of the year. “We believe that the overall growth trajectory will moderate over the next few quarters,” Commerzbank analysts Hao Zhou and Kai Wei Ang write in a report on the figures.

That, they believe, will result in a weaker Chinese yuan as a result. The Chinese currency will stand at 7.10 per US$1 by the end of this year, they say. That’s a drop of 3.1% now, and would mean the yuan lost 3.9% for the year, despite the best efforts of the central government to prop it up. Donald Trump has wisely beaten a retreat over his threat to declare China a currency manipulator.

The economic figures of course track macro trends, and matter more for long-term investors than short-term speculators. Investors in China appear to be more worried about the heavy hand of the law than the direction of the economy.

Chinese shares sold off on Monday for a second day, after the stock watchdog, the China Securities Regulatory Commission, said regulators would punish people found guilty of manipulating the price of recently listed stocks.

The large-cap shares in the CSI 300 index are down a modest 1.0% since that announcement. But some new listings such as Shanghai-listed mining company Baiyin Nonferrous Group and Shenzhen-listed Zhejiang Meili High Technology, which makes a variety of springs for vehicles, plunged the daily 10% limit on Monday.

Such “flash crashes” in specific stocks show that investors are running for the exits after sharp gains in such stocks earlier this month. Rigging and sling maker Juli Sling and property developer China Fortune Land Development suffered the same 10% decline, the maximum daily drop in China before circuit breakers kick in.




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