China

China’s New Normal of Slower Investment

By Leland R. Miller | The Wall Street Journal | April 14, 2015 | 2 pages

Investment is no longer the growth-driver it once was, but Beijing also needs to come to terms with the fact that consumption isn’t filling the gap.

During the second quarter of 2014, China’s official GDP performed its usual quarterly miracle, growing at exactly the government’s target rate of 7.5%. Through the prism of Beijing’s data, it was an unremarkable period, like many before it. But a closer look reveals it may have been the single most important quarter for China this decade.

The reason is found in data from our private survey of more than 2,000 Chinese firms each quarter, which marks it as the beginning of the end of investment-led growth. That is, not government officials talking about the end of investment-led growth, but the real thing.

No macroeconomic question is more pressing than how China will adapt to its so-called “new normal” of slower growth. With GDP statistics tightly controlled for political reasons and the figures for fixed-asset investment notoriously unreliable, most investors lack insight into how the key components of China’s economy evolve over time.

In the first quarter of 2015, our survey showed growth in firms’ capital expenditure easing for a fourth straight quarter, to the lowest level we’ve seen in four years of polling. Every sector except real estate saw slower investment in quarter-on-quarter terms, and real estate was sheltered only by its dismal performance at the end of last year.

Yet what is notable is not just the depth of the capex slowdown, but also its breadth. Virtually no corner of the economy over the past year has remained unscathed.

Since the second quarter of 2014, investment has eased materially in all eight of our regions, across every sector and for every size of firm. The slowdown hit foreign, domestic, private and even state firms without prejudice, all of which saw double-digit drops in the proportion that was hiking capex and increases in the number of those cutting it.

A breakdown by tier shows weakness intensifying inversely to size, ranging from a mild slowdown in Tier 1 cities to a near collapse in Tier 5. That media-grabbing Tier 1 cities are doing comparatively better may explain why overall weakness in business spending is so underreported.

With the slowdown in investment so glaring in the data, this raises the question: Why now? Our credit data suggests that most firms are no longer willing or able to borrow.

Some hear the stories of imminent defaults and want to start paying off heavy debts, or at least not incur new ones. And those firms that do want to borrow face a highly segmented credit market.

According to our data, interest rates paid by firms saw a mild decrease overall this quarter, matching the narrative that Beijing is trying to stimulate growth. But this obscures a sharply wider spread between rates charged by banks and nonbank financials.

Banks are charging less for credit but not lending more, instead confining themselves to less-risky customers. Other firms have to pay through the nose from shadow lenders or go without.

Bankers tell us they expect credit availability to rise in six months, with the share professing that notion jumping in the first quarter to the highest level we’ve seen in six quarters. But the share of companies expecting the same is substantially lower, and falling. Crucially, so is the share of firms expecting to actually borrow.

Pundits and bankers may be convinced that China is on the cusp of another major easing cycle. But China’s companies are not—or at least they do not believe that more affordable credit will be made available to the likes of them.

The credit and investment weakness may help the Chinese economy to rebalance. But there is little sign consumption is taking the lead in driving growth.

Retailers saw lackluster first-quarter results despite the Chinese New Year, normally the year’s top buying binge. Revenue gains in retail were minimal compared to the previous quarter, making these the weakest January-March numbers we’ve yet recorded. China’s evolution to a consumption-based economy may make a great slogan, but neither consumer demand nor retail sales to business and government is picking up the slack for investment.

This story has two major implications for investors. First, the debate over China’s willingness to alter its growth model should be laid to rest. Corporate spending has already embraced a painful new normal—whatever the intentions of policy makers.

Second, healthy rebalancing is not yet occurring, and it’s difficult at the moment to imagine a consumption boom big enough to offset the investment fade. Beijing will never acknowledge that the economy is in danger of stalling, but without a course change that possibility looms large.

Mr. Miller is president of China Beige Book International.