China’s 4th quarter GDP: glass half full?

You could read the new GDP data from China as very negative or surprisingly positive.

Here’s the negative story: 4th quarter GDP growth was 6.8% from the year-before, the lowest rate in seven years. Quarterly growth rate peaked near 14% in the second quarter of 2007 and has plummeted since then (Chart 1). The deceleration started in the property sector, which began to weaken early in 2008, and has since been exacerbated by the sharp fall in exports. Seasonally adjusted exports dropped 18% in November, from the month before (Chart 2).

The negative view assumes that these trends will continue and worsen. The industries hit immediately such as exporters and the heavy manufacturing (steel, cement) that depends on construction will release millions of workers, which will have negative spillover effects on all the other sectors of the economy. So, first quarter of 2009 will see even slower growth—some private analysts forecast as low as 2%—and recovery will take a long time.

The negative view sees continuing declines in exports because of the global slowdown and little prospect for real estate recovery soon (average housing price in all Chinese cities fell in December for the first time since these data have been collected). The government’s big stimulus package will start to have some effect by second quarter but it is not large enough to compensate for the declines in exports and real estate. It will limit the depth of the recession but cannot keep China from having a shockingly low growth rate of 4-5% in 2009.

On the other hand, I can the see the glass half full. We knew that fourth quarter was terrible for exporters and real estate: yet the economy still managed to expand at a 6.8% rate, which is very high in this global environment. Industrial growth has declined sharply, but primary sectors grew at 7.3% in the 4th quarter, and services at 8.0%. So, we are finally starting to see the desired rebalancing in which the service sectors become the growth leaders. Real retail sales growth was about 17.5% in both November and December. So, the Chinese consumer is a bright spot in an otherwise gloomy global picture. Is that the last hurrah before consumers retrench? Or an indication that consumption can play an increasingly important role in sustaining the growth rate?

The more positive view of China’s prospects holds that 4th quarter ’08 and 1st quarter ’09 will be the trough of the cycle. First quarter ’09 growth will probably be very poor, in the 4-5% range, so be prepared for some dismal numbers. But the optimistic scenario is that the economy begins to accelerate from the second quarter on. The stimulus package begins to have significant effects on construction and hence manufacturing. The optimistic scenario is more likely if the government recognizes the downside risks and substantially increases transfer payments through unemployment compensation, minimum income support, and the rural medical insurance scheme. I have written before that there is a lot of scope to increase public spending on social services and transfers. All of that is important to maintain confidence and to keep private consumption growing. Outside of a few key cities (Beijing, Shenzhen) I don’t think there was too much real estate over-construction. The long-run demographics still favor massive migration to the cities, so with the right policies there is a hope to restart residential construction during 2009.

All of this suggests that there is a lot more uncertainty about China’s growth rate in 2009 than in a normal year. As noted, some private forecasters are projecting 4% or less for the whole year, while others contend that for the whole year China can grow at 7-8%. I am known for being an optimist: I think China can grow at 7% or higher, but it does depend on following the right policies.