THE CHINA GROWTH SLOWDOWN HAS ARRIVED / THE WALL STREET JOURNAL

The China Growth Slowdown Has Arrived

Economic data showed investment and industrial growth weakening sharply

By Nathaniel Taplin


STEELY DETERMINATION
China Industrial Output, change from a year early (Tons)

After a year of positive surprises, the specter of a China slowdown is back.

During the first half of 2017, deflation was banished, debt defaults slowed, and growth rebounded.

Nonetheless, China watchers have long warned that tighter credit would eventually mean slowing growth again. This month, the first real evidence of that arrived: China’s official purchasing managers index was sharply lower than expected, and July industrial-production and retail-sales data released Monday were the weakest since February. Investment growth was the weakest since December.

The slowdown may catch some investors off guard. After buoyant second-quarter data, sentiment on China is at its most bullish in years. China growth plays like miners and construction-equipment firms will probably sell off on the news. But the very gradual ramp down in credit growth—far softer than in previous tightening cycles—still likely means a moderate, rather than drastic, economic slowdown in the closing months of 2017.

The weakness revealed by Monday’s numbers was broad-based—with the notable exception of the steel sector, where growth continues to accelerate in the wake of capacity cuts, which have helped to boost margins. Real estate and infrastructure investment both weakened, with the former growing at its slowest pace since June 2016. Growth in China’s massive information-technology sector—a good indicator of export strength—also slowed, in line with July’s PMI, which showed growth in new export orders weakening abruptly.

Combined with the weak retail-sales data, this isn’t encouraging news. There are, however, two big reasons to expect a mild rather than sharp slowdown. The first and most important is credit growth, which nearly always leads the overall growth trajectory in China. Here the news is good: In contrast to past tightening cycles in 2010 and 2013, the slowdown in credit growth has been quite mild. Growth in total debt-and-equity finance outstanding for households and nonfinancial firms, including local government bonds, has only slowed by around 2 to 3 percentage points since its early 2016 peak. By contrast, at this point in the previous tightening cycle, credit growth had already slowed by nearly 6 percentage points. Inflation has also been higher than expected, which means real borrowing costs for firms—and debt risks—remain contained for now.

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Change from a year earlier (Rmb)

The other reason for optimism is the political calendar. China is about to hold a key Communist Party meeting this fall to select its next generation of leaders. President Xi Jinping and his allies want slower growth and lower leverage, but they don’t want a dramatic drop at such a sensitive time.

The odds remain good that 2018, rather than late 2017, will be the year when China worries start to plague markets again. But investors should still expect some volatility in the days ahead as markets digest the first clear signs of stumbling growth in China this year.