China's growth - economic or accounting miracle?

Courtesy of Business Times Hock Lock Siew
Published September 1, 2009

By R SIVANITHY

BY now, most investors would be familiar with the China growth story - possibly 10 per cent GDP growth which has powered the country's stock markets' rise of more than 80 per cent this year alone. Even though there has been the occasional warning about a speculative stock market bubble, there is a smug belief that because this year is the 60th anniversary of the founding of the People's Republic of China, an image-obsessed government keen to cement the country's reputation as the next big economic powerhouse will do its utmost to ensure the party carries on - pretty much along the lines of the US, where the Treasury and Federal Reserve have pumped trillions into the system to keep Wall Street afloat and to keep up the appearance of a recovery.


This much is the conventional wisdom with regard to China - buy because you cannot lose, especially if the government is on your side. But conventional wisdom can always be challenged and for those who feel inclined to do a bit of probing, there's plenty to ponder.

Take the 8 per cent second-quarter growth which grabbed most of the headlines. Less conspicuous was that exports in June actually declined by 21.2 per cent year-on-year while first-half exports fell 20 per cent. These lesser-known figures beg the question: where did the growth come from?

The answer is, of course, the government. Late last year, a stimulus package equal to 14 per cent of GDP was launched to stimulate consumer demand and judging by the figures so far, it looks like it's working.

However, according to American Enterprise Institute visiting scholar John Makin, creative accounting plays a big part in creating the impression of robust growth.

In a recent article titled 'China: Bogus Boom?' (see http://www.aei.org/outlook/ 100061), Dr Makin wrote that the target 8 per cent annual growth figure will surely be achieved because the country's economic statistics are based on recorded production activity rather than expenditure growth, the latter defined as the sum of consumption, investment, government spending and net exports.

'The US stimulus package, for example, attempts to boost GDP by undertaking measures that will boost consumption, investment and government spending. China, however, decrees mea-sures that will generate recorded increases in production spending,' Dr Makin wrote.

'Once China had announced the 8 per cent growth target, it began to disburse funds directed at sharp increases in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher growth or production numbers,' he added.

'The same convention, counting production and shipments as de facto outlays by end-users, is employed with respect to retail sales data in China.

'Shipments to retailers are counted as retail sales on the apparent assumption that ultimately all goods shipped will be sold at some point in the future. China's nominal retail sales have been rising at a rate of around 15 per cent year-over-year over the first half of 2009 because that is the rate at which shipments to retailers have been occurring. There is very little data available to measure actual sales by recipients of the shipments to ultimate consumers.'

Quite correctly, Dr Makin questions the true health of the China economy and warns of inflationary pressure brought on by loose monetary policy.

Possibly the first - and only - broker to cast some doubt on the China 'miracle' story is DBS which, in its August Markets Update last week, warned against over-reliance on government support that it thinks can be withdrawn suddenly anytime over the next 12 months.

DBS also referred to the China market's high valuations, which it describes as 'unsustainable'. DBS is not wrong - according to Bloomberg's analytics, the Shanghai Composite sells for 31 times earnings and is supported by a paltry 1.4 per cent dividend yield, while the Shenzhen Composite's figures are much worse - 67 times earnings and 0.7 per cent dividend yield. Neither set of figures can be described as 'cheap', so the conclusion has to be that the market is expensive and is running on liquidity, much of which has been provided by the government. Such must have been the conclusion reached by most investors who yesterday sold off China stocks, dragging the major indices 7 per cent lower.

Given the high dependence of the local market on daily, minute-by-minute shifts in the Hang Seng Index, and because of the latter's reliance on events in China, local investors would thus do well to stay nimble and not place too much faith or money on the China growth story because the economic miracle could well be founded on an accounting miracle instead.