It is high time that investors realise that seeing GDP number for China in a standalone fashion has become obsolete. With its debt increasing at an unprecedented pace, other factors have also come into play. Hence it becomes important to judge the basis for analysing this figure on which so much depends.
GDP is Just a Number
According to Goodhart’s law, when a measure becomes the target, it no longer remains a good measure. An example of this (from ‘The Rise and Fall of Nations’ by Ruchir Sharma) comes from the very country under consideration.
Around 2014, analysts in China became sceptical of the GDP growth number given by the government. They started using electricity consumption as a proxy for it instead. It was a reliable method, until 2015, when reports emerged that government authorities were instructing developers to keep lights on even in the empty apartment complexes. Thus, numbers were fudged to meet the target, but no effect was seen in domestic consumption, government spending, investments or the trade gap for that matter.
China’s economy grew at 6.7% in 2016, the slowest in 25 years, but still within its set target of 6.5-7%. But China did miss its fiscal deficit target. Reuters calculation states that China’s preliminary fiscal deficit for 2016 was 2.83 trillion yuan, which exceeded the target of 2.18 trillion. This was because the government took to increased spending to stabilise the economic growth (which was the ‘target’) at the cost of the debt it took on its sheets.
This year China again revised its growth estimates in a similar negative direction as it did last year. According to a recent statement by Premier Li Keqiang, China is aiming to expand its economy by around 6.5% in 2017 as it continues “to implement a proactive fiscal policy and a prudent monetary policy”. The target is than previous year’s GDP growth of 6.7%. With an increase of 23% in the debt-to-GDP ratio over 2016, in comparison to last year’s 30% decrease, it seems China is factoring in its debt problems into its targets.
It is at the right time that China has realised that slowdown in an economy is a part of the business cycle. Instead of panicking in order to meet its sky-high target numbers, it should start looking more towards its fundamentals – even at the cost of higher growth targets – rather than achieving them in the near future by piling on more debt. The increase of a mere 2.5% of global GDP in 2015 was lower than before largely on account of the slowdown in China which, in turn, hits emerging economies because of their trade interdependence.
Investors’ Approaches Towards China
Some investors might point to how China’s debt burden of approximately 277% of GDP is lower than that of the US’ (331%). But what they miss is that for a country like the US, debt of this amount is not as severe because their per capita income stands at more than $50,000. On the other hand, China’s per capita income stands at just $10,000 (approximately). China’s debt burden mainly consists of private debt (with non-bank private debt-to-GDP reaching 200% between 2009-15) which includes ‘shadow lending’ (an instrument created by the provincial governments to fund pet projects and force investors into financial products that invest in companies with uncertain future outcomes).
Per capita income helps in improving standards of living for a country’s citizens. Low per-capita-income with huge debt means money that would otherwise be spent on things such as business investment, cars, homes, and vacations is increasingly diverted towards making payments on the growing debt — especially among middle- and lower-income groups that compose most of the Chinese population and whose spending is of paramount importance in driving the country’s economic growth. With China’s per capita income standing at just 20% of that of the US, it will become difficult for the Chinese population to contribute to the country’s growth and at the same time service the debt.
Investors need to get very cautious when it comes to China’s growth. They should take all the announcements and data with a pinch of salt. There are a few examples as to how they can do this:
- No infrastructural growth in China is good enough till it is accompanied by the source of funding as well as the revenue generation data.
Recently, China’s energy agency announced an investment of 2.5 trillion yuan into renewable power generation by 2020. This reflects its attempts to start curbing fossil fuels and its war against pollution. However, simply mentioning that 13 million jobs will be created in this sector by this investment is not enough. Knowing from where will this 2.5 trillion yuan be drawn and how much revenue will be generated by this, keeping in mind the ageing population and reduction in productivity, is paramount.
- Instead of focusing on GDP growth rate alone, emphasis should be laid on seeing it along with the fiscal deficit target.
The recent announcement by China that it met its GDP growth target of 6.7% is no good news as it did cross boundaries of fiscal deficit target. This simply means that China is desperately trying to attract investors to its country in the short-term while risking its future course of actions.
For 2017 also, an announcement of keeping its fiscal target at 3% of GDP is made. This should be seen together with the above-mentioned point wherein ‘the source of funding’ becomes an absolute necessity. If China continues to stay panicky towards meeting its numbers, disregarding the funding source, chances are high that it will cross the mark this year as well – which is definitely not a good sign. Also, portraying its superiority with announcements of investments in projects in various countries like Africa is of no use if it cannot keep its own economy healthy.
Analysing a country by its GDP growth number is very common. But one should get alarmed when one sees a country maintaining almost the same number target every year with no extra efforts on its part to deleverage it in light of a global slowdown, which makes even the most developed of economies like the US, Germany suffer.
China has the potential to regain the same pace it had in the last decade. Its realisation that slowdown is a natural part of the economic cycle which will gradually fade is made at the right time. China has nothing to be panicky about. It just needs to focus on reducing its debt and investing in China itself even if it means one or two years of low GDP growth numbers and less help to other countries. This will boost investor confidence in the strength of the economy for the investment purpose over a long-term horizon.