Vice President of Renmin Univeristy of China
Editor’s Note: By the middle of the year, China’s economic transcripts in the first half of 2018 will also be unveiled. In the face of the intricate internal and external environment, what will the endgame for the Chinese economy be like in the first half of 2018? What will China’s macroeconomic trend be in the second half of the year? What are the risks and challenges? What will change about the tone and thinking of economic policy? From now on, this newspaper has opened the “Midyear Observation” column, inviting think tank experts and scholars to share their views.
China’s macro economy was basically stable in the first half of the year
In the first half of 2018, under the background of internal prevention and mitigation of major risks and external dealing with Sino-US trade frictions, China’s macroeconomic fundamentals have remained basically stable.
First, the industrial growth rate remained at around 7%, and the service industry production index growth remained above 8%, creating a favorable macro environment for deepening supply-side structural reforms and promoting high-quality economic development. From January to May, industrial added value increased by 6.9% year-on-year, higher than that in the first quarter and that in the same period of last year; the service industry production index increased by 8.1% year-on-year, and remained above 8% for 5 consecutive months.
Second, the macroeconomic climate and confidence have increased, and the Purchasing Managers Index (PMI) continued to operate in the expansion range. In May, the manufacturing PMI was 51.9%, and the non-manufacturing business activity index was 54.9%, setting a high point in recent months.
Finally, the employment situation continued to improve. In May, the nation-wide urban surveyed unemployment rate was 4.8%, and the surveyed urban unemployment rate in 31 major cities was 4.7%. From January to April, the number of newly employed population in urban areas was 4.71 million, an increase of 1.3% over the same period last year.
Recent changes in China’s macroeconomic situation have triggered market divergence
In the first half of the year, China’s macroeconomic supply side remained basically stable, but the market has experienced serious divergences due to the recent new changes in the demand side, and some pessimistic sentiments have started to rise sharply. Grasping the nature of the changes in China’s economic situation requires an in-depth analysis of the following issues.
First, deviation between sound aggregate supply and weak aggregate demand. First, the growth rate of fixed-asset investment continued to show a downward trend, setting a new low in the past 20 years. From January to May, fixed-asset investment only increased by 6.1%, which was 1.4 percentage points lower than the growth rate of the first quarter and 2.5 percentage points lower than the growth rate in the same period last year. Although private investment has rebounded, it has not stabilized and its correlation with real estate investment has increased. From January to May, private investment increased by 8.1%, an increase of 1.3 percentage points over the same period last year, while a decrease of 0.8 percentage points from the first quarter of this year. Moreover, since the first quarter of 2017, the correlation between private investment and real estate investment has increased, indicating that the current recovery of private investment is largely due to the direct contribution of private real estate investment or the indirect impact of real estate investment.
At the same time, since 2018, the growth rate of total retail sales of consumer goods has not only fallen below 10%, but also showed a sharp drop in the second quarter. From January to May, the total retail sales of consumer goods increased by 9.5% year-on-year, down by 0.8 percentage points over the same period of last year. Among them, the growth of consumption in May fell to 8.5%, down by 2.2 percentage points from the same period last year. Compared with other macro variables, consumption generally performs relatively smoothly, and new changes this year have caused concern.
Finally, exports denominated in RMB increased by 5.5% year-on-year, 8.2 percentage points lower than the growth rate of the same period last year. The trade surplus decreased from 942.1 billion yuan in the same period last year to 649.8 billion yuan, a decrease of nearly 300 billion yuan, a decline of 31%.
Second, deviation between the trend of CPI changes and the trend of PPI changes. Consistent with the deviation between aggregate demand and supply side, since the first quarter of 2018, CPI has continued to decline, while PPI has rebounded. In May, CPI increased by 1.8% year-on-year, down by 0.3 percentage points from March, while PPI increased by 4.1% year-on-year, up by 1.0 percentage point from March. The variation trend of CPI reflects the impact of total demand contraction, while the change in PPI partly reflects the cost-driven effect from the sharp rise in international crude oil price. As of June 14, price of the British Brent crude oil rose to 75 US dollars/barrel, OPEC crude oil price rose to 74 US dollars/barrel, a significant increase of 64% and 63% over the same period last year, respectively. The sharp rise in international crude oil price will create significant cost pressures on production companies, making it difficult to stimulate domestic weak demand through price adjustments, so short-term macroeconomic pressures may be further exacerbated.
Third, deviation between real estate investment and sales growth. As the main supporting factor for fixed-asset investment in the first half of the year, real estate investment changes are still very important for judging the short-term economic situation. From January to May, real estate investment grew by 10.2% year-on-year, 1.4 percentage points higher than the growth rate in the same period last year, and 4.1 percentage points higher than the growth rate of fixed-asset investment. However, the sales area of commercial housing only increased by 2.9% year-on-year, a sharp drop of 11.4 percentage points over the same period of last year. The area of land purchased this year only increased by 2.1% year-on-year, which was a sharp drop of 13.7 percentage points from the growth rate of the last whole year. Therefore, the rising trend of real estate investment in 2018 may mainly reflect that with the continued tightening of real estate control policies, the behavior of developers has changed to passively accelerating construction under tight funding so as to quicken the recovery of funds. From January to May, the new construction area of housing increased by 10.8% year-on-year, showing a sudden acceleration trend.
Fourth, deviation between financial environment changes and financing needs. In the context of de-leveraging policies and financial risk prevention and mitigation policies, the financial environment has continued to tighten and has an impact on financing needs. In May, broad money (M2) grew by 8.3% year-on-year, and has continued to operate in the 8%-9% range since it fell to 8.1% in December last year. In May, the stock of social financing increased by 10.3% year-on-year, and continued to show a downward trend, dropped by 1.7 percentage points from December last year.
In order to maintain ample liquidity, the central bank has implemented three targeted RRR cuts this year. The first was a RRR cut targeted at inclusive finance, which was implemented on January 25. The second was the exchange of MLF by partial funds released from a targeted RRR cut, which was implemented on April 25. The last was a RRR cut targeted at enhancing the credit supply capability for small and micro businesses just proposed at the State Council executive meeting on June 20. Due to the recent policy adjustments by the central bank, liquidity has been continuously injected into the market, and the interbank market interest rate pivot has fallen from the high point at the end of 2017. The 3-month SHIBOR rate fell from 4.8% to 4.1%, and the 10-year national bond yield to maturity fell from 3.9% to 3.7%.
However, due to the tightening of loan conditions, financial institutions’ RMB loan rate pivot is still at a high level and has an asymmetric effect. In the first quarter of 2018, the weighted average loan rate of financial institutions rose to 6.0%, which was 13% higher than the cost of funds at the end of 2016. Among them, the cost of funds from ordinary loans, bill financing, and personal housing loans increased by 10%, 43%, and 20% respectively. The demand for loans has been affected, which, to a certain extent, led to a decline in the scale of social financing. According to the central bank’s banker survey, in the second quarter of this year, the loan demand index of large, medium and small enterprises fell slightly from the first quarter, falling from 61.1, 62.7, and 66.3 to 58.0, 60.6, and 64.5, respectively.
Fifth, deviation between fiscal revenue and infrastructure investment growth. From January to May, public fiscal revenue increased by 12.2% year-on-year, 2.2 percentage points higher than the same period of last year; government fund income increased by as high as 39% year-on-year, 11 percentage points higher than the same period of last year; with the two totaled, government revenue saw a growth rate of 17.4%, up by 4.3 percentage points over the same period of last year. In contrast, the growth rate of infrastructure investment decreased by more than a half. From January to May, the growth rate of infrastructure construction investment (excluding electricity) dropped to 9.4%, a sharp drop of 11.5 percentage points over the same period of last year. Given that the investment in electricity, heat, gas and water production and supply industry was a negative growth of 10.8 percentage points, the overall infrastructure investment declined even more. In fact, at present, the growth rate of three major types of infrastructure investment has dropped across the board, and many minor infrastructure investment items have seen negative growth. This raises a very important question, that is, why the government does not invest if it has money. It is worth noting that the national public budget expenditure in May only increased by 0.5% year-on-year, and local expenditure decreased by 1.2% year-on-year. Structural problems are further highlighted, and the government’s behavior pattern is changing. Due to the adjustment of government behavior, the motivation of local governments as an investment engine has been greatly weakened.
A rational look at the current changes in China’s macroeconomic demand
One should rationally look at the current changes in China’s macroeconomic demand. The current deviation between demand and supply is not so large. The macro economy is not as weak as the demand side reflects, and not as serious as many market participants have analyzed.
First, the growth rate of total retail sales of consumer goods can no longer represent the changing situation of Chinese consumption. The total retail sales of consumer goods mainly reflects the sales of physical goods, while a large category of consumption has not been covered, that is, consumption growth in the tertiary industry and especially in the service industry is not reflected in this parameter. A characteristic of service consumption is the concurrence of supply and demand when service occurs. Therefore, for the consumption demand reflected in the service category, the production situation of the service is its demand situation. From January to May, the production index of the service category increased by 8.1%, the electricity consumption of this category increased by 15.8%, the consumption of the Internet and related services, especially information transmission software, increased by 30%, and the tourism service consumption during the May Day holiday increased by 10.1% year-on-year. It can be seen that China’s consumption is not gloomy, but consumption has undergone essential structural changes. For example, the consumption of mobile phones has a certain degree of saturation, but when the penetration rate of mobile phones reaches 70%, the amount of related information service will continue to increase substantially, as evidenced by a 30% year-on-year rise from January to May this year.
Second, the core reason for the current decline in investment is the sharp drop in infrastructure investment. The growth rate of infrastructure investment dropped from more than 20% last year to around 9% this year, down by 11.5 percentage points. Infrastructure investment accounts for about 17% of investment. Therefore, changes in infrastructure investment caused the overall growth rate of investment to drop by about 2%, while the growth rate of non-infrastructure investment is still within the normal range. The first core factor is related to changes in local governments’ investment behavior. Institutional reforms are currently underway to achieve debt compliance and transform government functions. New officials must manage previous accounts, forming a system of accountability on debts. Therefore, the decline in investment, especially the decline in infrastructure investment, is closely related to changes and adjustments in government behavior, especially in local government behavior. Such changes will be a normal in the future. According to the objectives of the reforms, the functions of local governments should be restructured, transforming from the past control-oriented and investment-oriented governments to service-oriented and law-oriented governments. Such transformation requires the governments’ investment capacity to be weakened. Another important factor is “breaking the bubbles.” Currently, over 10 provinces and cities have already unveiled the “true form” of many investment parameters on a large scale. The proportion of total fixed-asset investment in GDP was 81% in the year before last and 77% in the last year. However, the final calculated gross capital formation only accounted for 44% of GDP, which indicates too many bubbles. Adjustments across the board are now underway. Local governments are not allowed to borrow money, engage in vanity projects, or add more bubbles to figure bubble. Under the demand for high-quality development, the new governments have already behaved on investment data. Therefore, regarding the current decline in fixed-asset investment, one should see the essence behind the phenomenon.
Third, denominated in US dollars, China’s exports are still relatively strong. Although the growth rate of RMB-denominated exports was only 5.5%, down by 8.2 percentage points from the same period last year, if denominated in US dollars, China’s exports increased by 13.3% from January to May, up by 6.2 percentage points over the same period of last year.
Therefore, after adding these factors together to re-interpret the data, one can find that the demand side of the Chinese economy is not as weak as many people have been saying. The actual situation of China’s macro economy is better than what’s reflected by public opinion and the market. The partial fall of demand is the result of reforms and adjustments, especially the adjustment of government behavior. But behind this, we need to focus on changes in government behavior, including local government debt control, institutional reform, and new-term effects after political ecology has been cleansed. Seen from the angle of reform, this is the pain that must be endured during the critical period.
For the macro-policy in the second half of the year, the boosting of confidence is very important. It is suggested that the macro-policy of the second half of the year be fine-tuned. The core of the fine-tuning is not simply to loosen, but to stabilize confidence. This is because the current effect of internal asymmetry plus the changes in the external environment have caused the market confidence that has just risen to drop significantly. The current period is crucial for reform and adjustment, and also crucial for behavioral reconstruction of local governments, state-owned enterprises, and financial institutions. Therefore, we do not advocate large policy adjustments. Instead, we should better maintain market confidence and guide expectations while maintaining strategic orientation and bottom line management.
Although the weak overall demand may exist in the medium term, the resilience and foundation of the Chinese economy have determined that the overall strategic direction has not changed. Comprehensive reforms must be carried out, and critical difficulties must be addressed in these two years. Although many reforms have been unfolded, the process of substantive reform is the key to tackling difficulties, and is also a logic that must be followed by other regulation and management measures. Therefore, in terms of macro-control, we must adhere to bottom line management and strengthen the primacy of reform. We should take the institutional reforms of the Party and the country as an opportunity to lay the foundation for reforms in other economic areas through the adjustment of governance and the reconstruction of government functions.
(Liu Yuanchun, Vice President of RUC and Distinguished Professor of Changjiang Scholars Program; Liu Xiaoguang, Research Fellow at the National Academy of Development and Strategy, RUC)
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