China in Transition

Chinese Economy Heading For a Soft Landing: Growth underpinned by the recovering housing market

Chi Hung KWAN
Consulting Fellow, RIETI

The Chinese economy is experiencing its lowest growth since the collapse of Lehman Brothers, as its potential growth rate has declined against the backdrop of a shortage of labor and weakening demand both at home and abroad. While investment and industrial production, which were growth engines in the past, are growing at a sluggish pace, consumption and the service sector have remained relatively firm, putting a brake on the fall in the growth rate. Although the sharp fall in stock prices since June 2015 has given rise to concern of a further deterioration in business conditions, the recovery in the housing market is likely to help the Chinese economy avoid a significant decline in the growth rate.

Slower economic growth accompanied by an improvement in the economic structure

Although the Shanghai Stock Exchange Composite Index has fallen by more than 40% at one point since June 2015, its impact on the macro economy has been limited. The economic growth rate in the third quarter was 6.9%, slightly lower than the 7% recorded in the first half of the year, mainly reflecting sluggish investment and net exports.

While the economic growth rate is slowing, an improvement in the economic structure has been observed. The growth engine is shifting from investment to consumption and from the secondary industry centered on the manufacturing sector to the tertiary industry, as the government's policy of promoting the "transformation of the pattern of economic growth" starts to bear fruit.

By industry, the growth rate of the tertiary industry from the first quarter to the third quarter of 2015 was 8.4%, higher than that of the secondary industry (6.0%). As a result, the weight of the tertiary industry rose by 2.3 percentage points from the same period of the previous year to 51.4%.

On the demand side, the contribution of consumption to the gross domestic product (GDP) growth rate in the first three quarters of 2015 reached 4.0%, higher than that of investment (capital formation) of 3.0% (Figure 1). Retail sales of social consumer goods (in nominal terms) also showed relatively high growth for the same period, increasing by 10.5% year on year, with sales online rising by 36.2% year on year. In addition, as symbolized by the fact that the growth rate of retail sales in rural areas has been higher than that in urban areas since 2012 (the growth rate in urban areas in the first nine months of 2015 was 10.3% year on year, while that in rural areas was 11.7%), consumption is firming in rural areas against the backdrop of higher income and increased sales online.

Figure 1: Growth Engine Shifting from Investment to Consumption
--Contribution to GDP Growth by Demand Component--

Figure 1: Growth Engine Shifting from Investment to Consumption
Source: Compiled by the author based on the CEIC Database (Original data from the National Bureau of Statistics of China).

Labor shortage under low growth suggests a fall in the potential growth rate

Although the current growth rate is at its lowest level since the first quarter of 2009 (6.2%), when the economy was affected by the collapse of Lehman Brothers, the employment situation now is stable in comparison. The job offers-to-seekers ratio, which demonstrates the balance between demand and supply of labor, fell to 0.85 in the fourth quarter of 2008, but has been following an upward trend since then and remained high at 1.09 in the third quarter of 2015 (Figure 2). The fact that it remains high despite a significant fall in the growth rate from the past level suggests that the supply-demand gap has not widened in the labor market, as the potential growth rate has also declined significantly, and the era where unless the economic growth rate reaches 8%, China will be destabilized by a sharp rise in unemployment, has come to an end.

Figure 2: Job Offers-to-Seekers Ratio Remains High Despite Slower Economic Growth
--Suggesting a significant decline in China's potential growth rate--

Figure 2: Job Offers-to-Seekers Ratio Remains High Despite Slower Economic Growth
Note: The job offers-to-seekers ratio shown above is calculated by dividing the number of job offers by that of job seekers registered in public employment services organizations in approximately 100 cities in China.
Source: Compiled by the author based on data provided by the National Bureau of Statistics of China and the Ministry of Human Resources and Social Security.

While the government implemented stimulus measures of four trillion yuan to boost domestic demand in order to maintain employment last time, such needs have not arisen this time. Calls for the implementation of a large-scale economic stimulus are mounting at home and abroad, but the Chinese government has been reluctant to respond actively to them based on this recognition. If the government strives to realize higher growth than its potential rate with expansionary fiscal and monetary policies, the economy will be destabilized by the emergence of a bubble. The Chinese government, which has come to recognize that the root cause of many problems it is currently facing, such as excess production capacity, heavier debt of local governments, and expanding loans by shadow banking lies in the excessive stimulus measures implemented to boost domestic demand after the Lehman Brothers bankruptcy, has adopted a more cautious stance this time.

Trends in the housing market are the key to determining the future course of the economy

The course taken by the housing market is the key to China's short-term economic outlook. If housing prices fall sharply along with stock prices, the Chinese economy could fall into the type of long-term stagnation suffered by Japan after the economic bubble burst in the 1990s. Fortunately, there is a negative correlation, rather than a positive one, between stock prices and housing prices in China, in contrast to other countries. This appears to reflect the fact that the large-scale movement of funds between the stock market and the housing market brings about an inverse correlation in their prices in an environment where investment opportunities are limited to either stocks or houses.

In fact, from early 2013 to mid-2014, when housing prices were rising sharply, stock prices were weak. In contrast, when housing prices entered a correction phase in the second half of 2014, stock prices began to rally. Funds began to flow into the housing market following the collapse of stock prices after June 2015, and housing prices are picking up mainly in first-tier cities such as Beijing, Shanghai, Guangzhou, and Shenzhen (Figure 3). The rise in housing prices is expected to lead to the recovery of housing investment before long, and this is likely to help the Chinese economy avoid the worst-case scenario of a hard landing for the time being.

Figure 3: Negative Correlation between Housing Prices and Stock Prices
Figure 3: Negative Correlation between Housing Prices and Stock Prices
Note: Monthly average. The average sales price indices of newly constructed homes in 70 cities are used. First-tier cities in the price indices of residential buildings are Beijing, Tianjin, Shanghai, Guangzhou, and Shenzhen.
Source: Compiled by the author based on the CEIC Database.

The original text in Japanese was posted on November 24, 2015.

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