July 15’s data on GDP growth beat expectations and growth in industry picked up again recently on a monthly basis, suggesting that the policy easing measures taken since late last year are starting to have an effect.
GDP growth in the second quarter was held back by continued weakness in investment, while export momentum slowed but private consumption held up better. In the housing market, sales growth remained brisk in June. However, amid still high inventories of unsold housing, housing construction is not yet benefiting from the better sales growth. On the other hand, infrastructure investment benefits from its key role in the government’s policy efforts to support growth.
But the downward pressures on growth stemming from the weakness in industry amidst the property downturn have been dampened by the robust expansion of the service sector. Value added in the tertiary sector significantly outgrew that in the secondary sector in the first half of 2015, especially in nominal terms, due to large differences in pricing power. With employment in industry not growing anymore, job creation in the expanding service sector is critical to support urban job growth and the migration of workers from the rural areas.
The still reasonably healthy urban job market supports continued solid growth in wages and consumption. However, a significant slowing of passenger car sales in recent months points to a risk that consumer confidence may be affected by the lingering weakness in industry. Going forward, the stock market turmoil may also affect consumption somewhat.
The strong showing of the service sector is necessary and sustainable. With the weak growth in industry, solid expansion in services and a relentless change in the relative price in favor of services is the key to rebalancing China’s economy.
However, since mid-2014 the service sector received a significant boost from the stock market rally and the associated activity. We expect the sharp correction in the stock market will have considerable effect on the turnover in the financial sector, which could shave around 0.2 percentage points or so off GDP growth in the third quarter. Indeed, this may be the most significant channel via which the stock market turmoil impacts the real economy－more significant than wealth effects.
Export momentum was subdued in the second quarter, but, in our view, is not as weak as the official data suggests. And it picked up a bit in June. Meanwhile, according to Royal Bank of Scotland estimates, the momentum of “normal” imports－used in China’s own economy－improved significantly in June, supporting the impression that domestic demand momentum improved in June.
Building on the recent developments, the headwinds to growth are likely to mitigate somewhat in the second half of the year, even as the downward pressure from the weakness of real estate construction remains, meaning that GDP growth should not be much weaker than 7 percent this year, while Consumer Price Index, a gauge of inflation, should end the year at around 1.8 percent.
Of course, risks to growth remain. Internationally, the key risks remain global monetary and exchange rate upheaval and weaker-than-expected global trade growth. In China itself, the risks of a more pronounced real estate downturn and a material decline in infrastructure investment have receded, in part because of the recent actions and plans of policymakers. However, the risk remains that the weakness in the industrial sector will spill over into the broader economy, via channels such as the labor market and confidence. The economic impact of the stock market turmoil on the real economy is manageable, but, as noted, the impact via lower activity in the financial sector is quantitatively significant.
Macroeconomic policy is likely to maintain an easing bias in the coming months to ensure that GDP growth will not fall back again. Thus we can expect continued efforts to boost infrastructure financing. The recent stock market turmoil will by itself also tend to call for an easy monetary policy stance. But the recent pickup in growth in industry makes significant further stimulus steps unlikely, while the scope for interest cuts is limited. We may see one more 25 basis points cut in benchmark interest rates this year. But even at their current level of 2 percent, benchmark deposit rates will remain just above inflation in early 2016. This limits the scope for further rate cuts, since the central bank traditionally does not like to see negative real benchmark deposit rates for a long time. On the other hand, the stance with regard to liquidity management and bank lending is likely to remain generous.
The author is China economist at the Royal Bank of Scotland.