For anyone foolhardy enough to make Chinese economic forecasts, a constant problem is the lack of crystal balls at hand.
The usual arsenal of predictive tools in other countries – yield curves, stock prices, purchasing manager surveys, Conference Board and OECD indices – all exist in China. But all are market-based measures, making them deeply flawed in an economy which is so heavily managed by the government. So what to believe?
Three leading analysts who cover China have in recent weeks revealed their frustrations at the paucity of leading indicators, but also made a few novel suggestions.
Stephen Green and colleagues at Standard Chartered looked at a series of unconventional data points: wheel-loader and excavator sales, steel and cement production, and projects under construction. Their conclusion was that cement output and construction were indeed useful, but didn’t function as leading indicators. That is, they closely track investment activity in real time, but “there is very limited leading information here”.
Jonathan Anderson, who left UBS this month, used one of his last research notes at the bank to savage the idea that purchasing manger indices (PMIs) are even remotely useful in China. Not only did PMI numbers fail to predict the country’s downturn in late 2008 and recovery in early 2009, they were actually late in detecting the economic changes and thus misleading as coincident indicators.
He writes: “Did this show up in the PMI? Hardly. In fact, if you were watching the index you essentially had no idea that any of this was going on.”
What, then, can we rely on if we want to get a feel for where the economy is headed?
Green reaches for an old stand-by: “After following one tantalising clue after another, we are still left with credit growth as the only leading indicator of investment.”
The beauty of looking at credit growth in China is two-fold. The financial system is dominated by bank lending, making credit issuance far and away the most important factor in liquidity conditions and hence also the best predictor of investment activity. What’s more, credit growth is closely managed by the government through a loan quota system, so it does a good job of reflecting Beijing’s policy preferences, not just market sentiment.
Du Jinsong, a property analyst with Credit Suisse, makes a more unusual proposal for a leading indicator: the production of bricks and pre-stressed concrete piling. To be clear, he is only thinking of these as predictors for property construction – they seem to lead new housing starts by about eight months.
But property is the dominant component of Chinese investment activity and the broader economy is led by investment, so getting the real estate market right would be a very good start.
There is only one problem. The leading indicators proposed by Green and Du point in slightly different directions.
Looking at credit growth, Green forecasts a moderate pick-up in investment growth in the second quarter. Looking at brick and piling production, Du says property construction will probably remain flat for the next six months.
Now, it is of course possible that both are right. Investment growth may accelerate, just not in property. But given China’s frustrating track record for would-be oracles, it is also possible that at least one of the two may be more of a red herring than a leading indicator.
Very interesting post about the tools available to economists for predicting economic growth in China.