Reading tea leaves for signs of China's recovery

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What to make of it when, within a few hours last week, the statistical bureau depressed us with a 26% decline in exports for February and then elated us with a 27% increase in urban fixed asset investment? These two figures capture nicely the struggle that is going on within the Chinese economy.

We launched our China Quarterly report today with our take on how to reconcile the conflicting data. Clearly, the global economy is in very poor shape. Global GDP declined at an annualized rate of 5% in the fourth quarter of 2008, and global industrial production declined at a 20% rate. These are shocking numbers that those of us born after the 1930s have never seen. Naturally this has had a large effect on China, which is an open, export-oriented economy. China's seasonally adjusted monthly exports peaked at around $120 billion last fall, and then fell off a cliff – dropping by about one-third ( see chart).

The other obvious area of weakness is the real estate sector. Even before the global crisis began to affect China, the problems of excessive price rises and over-building were apparent. In the first two months of 2009, real estate investment showed zero growth over the year before. So, two important sectors of the economy – real estate construction and exports have either zero or negative growth.

But it is not all bad news. The government's 4 trillion Yuan stimulus package is for real and is already having visible effect. Infrastructure investment is rising rapidly: railway investment, for example, is up more than 200% from last year. This has backward linkage to industries such as cement (real production up 17% in January-February from the year before). Real retail sales have held up quite well (up 15% in January-February from the year before) indicating that many households are spending the large increases in income they have seen in recent years.

We feel that these data tell a complex but coherent story. Export-oriented manufacturing and real estate construction are in decline, while at the same time there is rapid growth in infrastructure investment, manufacturing industries tied to that, and household consumption of both manufacturing items and services.

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For me, the best "bottom line" measure on a monthly basis is real growth of industrial value added. This showed a 3.8% increase in January-February compared to the year before. Only a year ago this measure was growing about 15% ( see chart). The 3.8% growth rate combines the bad news in the export sectors with the good news in the manufacturing sectors linked to infrastructure or household consumption. Since industry is about half the economy and January-February is two-thirds of the first quarter, this number is a kind of preview of the first quarter GDP data. First quarter GDP growth may be somewhat better than this because we are hoping that services are growing faster than industry now and that the industrial economy has already hit bottom and is accelerating over time.

For the same reasons, we are projecting 6.5% GDP growth for China in 2009 as a whole. We see the first half of 2009 as the worst of the crisis, for China and for the world. There is likely to be some pick-up in exports and real estate investment from the current depressed levels. Meanwhile, the stimulus package will continue to have effect.

The 6.5% projection is a one percentage point markdown from our estimate last November. At the same time, the World Bank has marked down its forecast for global GDP two and a half percentage points, from a 1.0% gain to a 1.5% decline. So, we remain relatively optimistic about China, projecting it to grow 8 percentage points faster than the world average. Whether China can grow at 6.5% or better depends not just on the state of the world but also on China's policies. In the next few days my colleague Louis Kuijs will provide some thoughts about China's policies in the current environment.