The Chinese "hard-landing'

-- This is a zero sum game: Everyone ends up with zero. -- Jenna Orkin

How To Crash The Chinese Economy

A sub-7% GDP growth is what most people call a “hard landing” for China.  While that would be a very low rate for China, it is hard to argue that it is actually very bad

Business Insider,

18 May, 2012

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A sub-7% GDP growth is very easily reached.  In fact, I have noted previously that using the quarter-on-quarter data, the annualised growth rate has slowed to just 7.4%.  We only need the economy to grow a little bit slower to reach that.

Given how close it is to the so-called hard landing, it is interesting that many still refused to believe the possibility of a sub-7% growth.  Perhaps some have been prepared for such a growth figure, it might be fair to say that the market consensus has not thought about anything more severe than a growth figure between 5-7%.

The calculations below take the rough percentage of different components’ contribution to GDP as the starting point, and make different assumptions about how each component grows or shrinks from the starting point.  The calculations below are not meant to be very precise, but is meant to show that it is very easy to get growth rates way below what even bears are contemplating.  In particular, we should note that because investments are such a big portion of the economy, even a modest contraction in investments can be hard for other parts of the economy to offset.

Starting point: assuming that annual GDP in nominal term ~ RMB49 trillion

The contributions of each part of component of the GDP, roughly, are as follows (note again that this is not meant to be very precise):

Investment contributes roughly 50% of GDP

Private consumption contributes roughly 34% of GDP

Government consumption contributes roughly 14% of GDP

Trade Balance contributes roughly 2% of GDP

While I am expecting a deflationary scenario for the Chinese economy, for simplicity sake, the calculations below assume that there is no inflation nor deflation.  That is the nominal growth will be the same as real growth.

The not-so-severe assumptions

Among investment, parts of it are real estate, which accounts for 10% of GDP.  As we noted that new housing start is down this year, it is no longer unreasonable to assume negative growth for this portion of the economy going forward.  Let us assume a 10% drop for the next 4 quarters compared to the previous 4 quarters.  Other parts of the investment will also be affected, although the magnitude of the negative would be hard to quantify.  Let us assume that investments excluding real estate would fall by 5% in the next 4 quarters.

For private sector consumption, with slower economy, growth in retail sales growth has been slowing.  If the trend continues, we should not be surprised if retail sales growth (assuming that it’s a good indication of private consumption in the GDP calculation), which currently stands at 14.1% in nominal term (10.7% in real term), to fall to single digit.  Assuming that the growth for the next 4 quarters, on average, is 8% compared to the previous 4 quarters (Note that this is not a particularly severe slowdown assumption in consumption).

For the government spending, while it is theoretically possible to increase it so that GDP can be sustain, let us for a moment assume that the level of government spending remains totally unchanged.

For trade, it would be reasonable to assume sharp and sustained fall in exports, particularly in Europe.  But trade balance could remain more or less stable because on the other side, imports demand will also be falling substantially because of falling domestic demand.  Thus let us assume that trade balance will not grow nor shrink for the next 4 quarters.

The resulting overall GDP growth, unfortunately, even under this not-so-aggressively-bearish scenario, is –0.3%.

More severe assumption 1: private consumption no longer grow

Because of the fall in housing prices, and as said previously that housing has a larger wealth effect on consumption, it is not unreasonable to assume that consumption is not growth at all.  All else being equal, with consumption growth slowed to 0%, the resulting GDP growth is –3.0%.

More severe assumption 2: not only real estate investments fall by 10%, other investments also falls by 10%

Even more sever assumption: now even consumption starts to fall

Bullish assumption: Government to save the day, reversing part of the fall in investments, while consumption grows at 10%

The government, of course, can increased spending to give the economy a boost.  Assume that government consumption expenditure is increased by 15% to offset the contraction in investments and to support consumption, under this particular set of assumptions, GDP growth would only be 4%.