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This China Slowdown Is Different

By Leland R. Miller and Craig Charney | The Wall Street Journal | July 14, 2014

China announces official second-quarter GDP on Tuesday, a figure widely expected to reflect official guarantees of continued strong growth. But data from the China Beige Book—a private survey of 2,200 firms nationwide—suggest that the Chinese economy isn’t expanding as Beijing’s numbers would imply. Actually, the second quarter saw another broad-based slowdown.

Yet it is hardly news that GDP isn’t a reliable gauge of growth or credit conditions across China’s economy. The real news is that this slowdown may be the beginning of something much more important: weakness, perhaps of unprecedented degree, in both capital expenditure and loan demand.

Economic analysts have for years called for China to curb investment-led growth. Now that process may be beginning—and it won’t be painless.

A year ago, the weakening of the economy was due primarily to a tightening of credit. In early 2013—while many analysts remained glued to the government’s “total social finance” credit measure—our research data revealed that companies had escalating difficulties in accessing credit, a trend that began as early as the fourth quarter of 2012.

A few months later, Beijing’s central bank became more forceful in its policy response, declining to feed the credit beast its usual meal of loan rollovers. That led to spikes in interbank lending rates, including the June 2013 credit crunch.

Our survey data this quarter reflect a very different dynamic: broad-based falls in capital expenditure growth and a related further fall in loan demand. Back in the second quarter of 2013, loan demand remained high but many couldn’t access credit, driving those firms to more expensive shadow lenders. But this quarter firms simply didn’t want the credit. Loan demand hit the lowest level since our survey began in the first quarter of 2012.

The lack of demand can’t be seen in interest rates on bank loans, which rose a bit this quarter and often reflect institutional relationships as much as real changes in market demand. But it is manifest in rates charged by non-bank financials, the so-called shadow lenders. Shadow bank rates plunged to below those charged by the banks, for the first time at the national level.

Firms watching the economic slowdown didn’t want to spend. At the national level, capital-expenditure growth slowed broadly this quarter, as did firms’ expectations for future spending. Fewer firms increased investment than at any time since our survey began.

The worst slowdown was in mining, where the share of firms increasing their investment spending collapsed by almost 30%. Services firms followed with a 20% drop, and manufacturers dropped nearly 20% despite a relatively solid quarter of growth. The only sector to increase investment slightly was real estate and construction, but even there the on-year trend showed weakness. The proportion of real-estate firms expecting higher investment next quarter also dropped, while more firms said they expect to cut spending.

Capital expenditure in retail is best reflected by retailers’ willingness to open or close stores. In China’s central region, including megacity Chongqing and Sichuan province, outlet expansion fell off a cliff. Just 22% of firms increased their number of outlets—a near 50% drop from the first quarter—while 18% are cutting stores, more than twice as many as last quarter.

There is a chicken-or-egg problem with capital expenditure and the labor market, but the outcome is clear: The labor market is seeing depressed growth in hiring and wages.

If official data are at all accurate, Chinese capital expenditure is the weakest it has been in more than a decade—and evidence suggests that this investment downshift may be difficult to reverse. A year ago, tighter credit constrained growth and the central bank had the option of loosening again. This quarter, lower non-bank interest rates failed to support investment.

There are considerable advantages to this dynamic, as China badly needs investment to decline and consumption to grow. But these numbers suggest that firms are borrowing and spending less, not ratcheting up in response to anticipated or actual government stimulus.

If so, this isn’t a slowdown with Chinese characteristics, as some have argued. It is the opposite: a normal slowdown. That bodes well for China’s long-term fortunes but also suggests that slowing investment will produce a much bumpier ride than many have hoped.

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