Chinese Economy Slumps to Slowest Growth Since Crisis, Stricken by Double Blow

A Slow Start

China's first-quarter growth came in at 8.1% in year-on-year (y/y) terms, the weakest growth in almost three years. External weakness has played a significant role in the slowdown, dragging down headline GDP growth by 0.8 percentage points, according to the national statistics authority. Indeed, Chinese shipments recorded their slowest growth since the crisis in the first quarter, at just 7.3% y/y—down from the 20.3% y/y growth for the year of 2011 and the 26.4% y/y gain recorded for the first quarter of 2011. Slower investment is another negative, with capital formation's contribution to GDP growth down sharply to 2.7 percentage points, almost halved from both the 2011 level and the annual average over the past decade. Indeed, urban fixed-asset investment slowed to a decade-low of 20.9% y/y, pulling back quite significantly from last year's nearly 24% y/y growth, reflecting much slower housing and infrastructure construction. The only sector that has held up well is consumption, with final consumption's contribution to GDP growth amounting to 6.2 percentage points, higher than the average 4–5 percentage points reported over the past decade.

Mirroring troubles in the construction and exports sector, China's industrial output growth retreated to 11.6% y/y growth in the first quarter, dragged by much slower growth of heavy industry output, particularly output in sectors such as non-ferrous metals and transport equipment—which grew only 8.7% and 5.9% y/y respectively, mainly reflecting distress in steel, shipbuilding and other troubled sectors. Light industry's expansion has been stronger, coming in at 13.2% y/y, attesting to the resilience of consumption.

Outlook and Implications

Consolidation, Not Collapse

While first-quarter growth is quite weak, it is nowhere close to the collapse seen in the final quarter of 2008 and first quarter of 2009. Furthermore, green shoots have already started springing up in many cyclical sectors, such as steel and chemicals, leading IHS Global Insight to increasingly view the current slowdown as more a slow consolidation than another precipitous downturn as seen in 2008–09. The export-demand slowdown is still isolated in Europe, unlike a worldwide collapse in 2009. Domestic demand is also not as weak as the early months of the 2008–09 downturn before the massive stimulus kicked in. It is significant that the government has thus far resisted unleashing any substantial stimulus.

The first quarter is likely to prove the weakest quarter of this year, and China could easily overshoot the government's 7.5% growth target to deliver a soft-landing growth rate at over 8% this year. For one thing, low-cost housing is a key backstop preventing a crash of the housing construction sector. The first quarter's very weak investment growth is a little disconcerting, but the chances are high that this could be the bottom as credit conditions have eased considerably compared with the final quarter of 2011, which is conductive to investment expansion. On the external side, the odds are also high for Chinese exports to rebound after the first quarter, as it is increasingly clear the ongoing Eurozone debt crisis is unlikely to become a repeat of the 2008 US sub-prime financial crisis in terms of its negative impact on global demand.

Exports Outlook

The exports slowdown is significant, but it is not a free-fall collapse either. Indeed, during the 2008–09 financial crisis, China's PMI export orders diffusion index first dropped into the negative—below 50—territory in July 2008, before freefalling to a 29.0 trough in November of that same year. In all, the export orders index stayed in the below-50 zone for ten consecutive months. Similarly, peak-to-trough growth of goods exports amounted to as high as nearly 50 percentage points from October 2008 to May 2009. Overall, exports contracted for 13 straight months during the 2008–09 global recession. By contrast, during the current Eurozone crisis China's export orders index only fell below 50 for five of the six months between August 2011 and January 2012, and has rebounded into the 50-plus zone since February. Further, goods exports on the whole have remained in growth territory—only exports to EU have contracted, and only by a marginal 1.8% in the first quarter. As we expect growth in the United States and the emerging markets to gain some momentum during the rest of this year, Chinese exports should recover.

Policy Outlook

We believe the government has started regaining grip over the pace of slowdown, thanks to the stabilisation of external conditions. This will enable the government to continue with the consolidation of the real sector and financial sector, which are of higher priority in the medium term. Consequently, policy easing will remain measured, just enough to smooth out the cycle so as to prevent the collapse of weak links such as small- and medium-sized enterprises (SMEs). We expect two to three reserve-ratio requirement (RRR) cuts this year (50 basis points for each cut), moderately slower appreciation of the renminbi (from expected 5% to 2–3%), and some small-scale, sector-focused fiscal relief if needed. Much of the monetary and fiscal stimuli will quite likely be implemented in the second quarter.