China’s Economy Is Recovering

By Leland R. Miller and Craig Charney | Insights | Series II | No. 9 | July 2015

After several disappointing quarters, there are signs of improvement—just not for the official reasons.

China released second-quarter statistics Wednesday that showed the economy growing at 7%, the same real rate as the first quarter but with stronger nominal growth. That result, higher than expected and coming just after a stock-market panic, surprised some commentators and even aroused suspicion that the government cooked the numbers for political reasons. While official data is indeed unreliable, our firm’s latest research confirms that the Chinese economy is improving after several disappointing quarters—just not for the reasons given by Beijing.

The China Beige Book (CBB), a private survey of more than 2,000 Chinese firms each quarter, frequently anticipates the official story. We documented the 2012 property rebound, the 2013 interbank credit crunch and the 2014 slowdown in capital expenditure before any of them showed up in official statistics.

The modest but broad-based improvement in the Chinese economy that we tracked in the second quarter may seem at odds with the headlines of carnage in the country’s financial markets. But stock prices in China have almost nothing to do with the economy’s fundamentals. Our data show sales revenue, capital expenditure, new domestic orders, hiring, wages and profits were all better in the second quarter, making the improvement unmistakable—albeit not outstanding in any one category.

In the labor market, both employment and wage growth strengthened, and prospects for hiring look stable. This is not new: Our data have shown the labor market remarkably steady over the past year, despite the economy’s overall deceleration.

Inflation data are also a reason for optimism. Along with wages, input costs and sales prices grew faster in the second quarter. The rate is still slower than a year ago, but at least this is a break from the previously unstoppable tide of price deterioration. While it is just one quarter, our data suggest deflation may have peaked.

With the explosive stock market run-up occupying all but the final weeks of the quarter, it might seem reasonable to conclude that this rally was the impetus behind the better results. Not so. Of all our indicators, capital expenditure should have responded most positively to a boom in equities prices, but the uptick was barely noticeable.

The strength of the second-quarter performance is instead found in widespread expanding sales volumes, which firms were able to accomplish without sacrificing profit margins. The fact that stronger sales, rather than greater investment, was the driving force this quarter is itself an encouraging sign in light of China’s longstanding problem of excess investment and inadequate consumption.

These gains also track across sectors, highlighted by a welcome resurgence in both property and retail. Property saw its strongest results in 18 months, buoyed by stronger commercial and residential realty as well as transportation construction.

Six of our eight regions were better than last quarter, led by the Southwest and North. The results were also an improvement over the second quarter of last year, if somewhat less so, with residential construction the sector’s major remaining black eye.

Retailers, meanwhile, reported a second consecutive quarter of improvement, both on-quarter and on-year, with growth accelerating. For the first time in 18 months, the retail sector also had faster growth than manufacturing, underscoring the danger of treating manufacturing as the bellwether for the economy.

But there is still cause for concern. Retail performance was stronger among those selling mainly to business and government, suggesting underlying fragility. Cash flow remains critically weak in property, which must be addressed for the rebound to be sustained. Borrowing remains perilously close to the record lows in our survey.

Last quarter’s improvement must therefore still be seen within the context of a long-term overall slowdown. But the results serve as a useful reminder that it’s risky for investors to simply extend out the prevailing trend line.

Mr. Miller is president and Mr. Charney is research director of China Beige Book International.