Uptick

The Chinese economy is in rude health

by Bradley Gardner

For a moment there was a reason to be scared. In the early part of June media and analyst reports were filled with predictions that the Chinese property bubble was bursting. Real estate prices in the country’s nine largest markets dropped 4.9% in April from a year earlier， after having risen 21.5% the previous year and 10% the year before that. Property prices across China rose 5.1% according to Chinese property consultant Soufun， a substantial decrease from a year prior. April also saw a significant drop in sales and construction volume. Even copper prices， a major input for the Chinese property boom， dropped 5% since early March.

Then in May growth trends largely went back to normal. Housing starts grew 22.2% year-on-year， while property sales increased 18.5%. More importantly the temporary decrease in sales had almost no effect on growth trends in steel consumption， and had only a temporary impact on imports， which grew 28.4% in May after slowing to 21.8% growth in April and 27.3% growth in March.

Analysts were quick to point out that it is still too early to say which direction property prices and sales are heading. But the longer the trend continues the better it will be for the macro-economy. The government is investing in 10 million units of social housing across the country， but only 34% of them had started construction by the end of May， according to local media reports. This means that even if China continues to tighten the supply of capital， as it is expected to do， and housing prices flatten or turn slightly negative for some time， this state-led investment is likely to continue to support the more important subsidiary sectors such as steel production and concrete.

Looking at Beijing， a city whose property market was somewhat more bubbly than others over the past year (second tier cities are far more important for sustainable growth in this sector)， one can see an extreme example of this trend. Real estate sales in Beijing dropped 30.6% in 2010， while investment increased 24.1%. The drop in sales for residential real estate was 36.1% while the increase in investment in this sector was 66.4%. The effect of policy tightening was clear from a 39.2% drop in purchases through mortgage financing and a 71.7% increase in self-financed purchases.

Other economic indicators have largely followed the property sector’s lead – not surprising since property makes up around 13% of China’s GDP. National industrial value-added output grew 13.3% year-on-year in May， 0.1 percentage points lower than in April， and stronger than expected. Urban fixed asset investment grew 26.7% in May， up from 26% in April， focused largely on manufacturing and real estate， as opposed to infrastructure， though Chinese government investment in infrastructure drove the 2009 recovery. The Purchasing Managers Index (PMI)， a measure of industrial activity， rebounded after nearing negative levels last month. The statistics seem to indicate that industrial de-stocking has been taking place， and that China hasn’t actually faced any major bottleneck to growth in the past six months.

Except inflation. Inflation， currently running at a high 5.5% as of May， is not a severe problem as it mostly pertains to food supply rather than broad-based demand growth. Food prices were up 11.7% year-on-year， largely due to base effects and droughts. With increasing year-ago numbers and a new harvest in August and September it is unlikely the current inflation rate will continue into the autumn. Producer price inflation， a leading indicator of non-food inflation， actually declined from 7.3% in March to 6.8% in April and May.

The flexibility of China’s wages in the long run remains an open question， as the country’s manufacturing industry attempts to upgrade to higher-technology goods which require more highly-skilled labor to produce， and unskilled labor loses its price competitiveness with cheaper areas of Asia. The labor surplus which kept the Chinese inflation rate slow and low over the past decade (South Korea routinely faced inflation of 5-7% during this stage of its development) may be hard to maintain， as educated workers expect a middle class lifestyle， and factories face logistical hurdles in trying to access cheaper unskilled labor in inland regions.

As of now， though， the Chinese economy is in rude health. How long it stays this way depends on how the property market develops. The differences in the April and May data are large enough to make establishing a credible trend difficult， but at the moment things are looking positive.