The Chinese economy is off to a healthy start in 2017, with corporate earnings trending up and concerns about trade tensions with the Trump administration trending down. Steady growth provides Beijing with an opportunity to focus on reducing financial sector risks.
Profits at larger industrial firms (including many companies not listed on a stock exchange) rose 32 per cent year-over-year (YoY) during the first two months of 2017, up from a 5 per cent growth rate during the same period in 2016.
This trend began to develop in the fourth quarter of last year, when median earnings growth for the Chinese companies held by Matthews Asia continuously for the last two years rose 26.4 per cent YoY, up from 11.3 per cent during the fourth quarter of 2015.
The key drivers of this earnings improvement were increases in construction activity (infrastructure and residential) leading to stronger demand for materials and equipment, as well as supply-side constraints which led to higher raw material prices.
Improved profitability is likely behind the jump in confidence among entrepreneurs surveyed by China’s central bank, with that confidence index last month hitting a two-year high.
The combination of stronger profits and sentiment may deliver higher business investment spending in the coming quarters. Fixed-asset investment by privately owned industrial firms rose 7.6 per cent YoY in March, the fastest pace since 2015. And a recent survey of privately-owned small and mid-sized manufacturers by the broker CLSA found an uptick in capex plans for 2017. Those manufacturers also reported that in the first quarter they raised wages for unskilled workers by 4.5 per cent, up from 3 per cent in 3Q16.
While the YoY growth rates for all of these data points are likely to slow in the coming months, we expect activity levels and raw material prices to remain relatively high through the rest of the year, which may support stronger earnings growth for several more quarters, particularly in light of a weak base during the first three quarters of last year.
It is worth noting that higher factory gate prices have not spilled over into higher consumer price inflation. In March, CPI rose 0.9 per cent YoY.
Domestic demand still healthy
While China remains the world’s best consumption story, some YoY growth rates continue to decelerate. Following a decade in which real (inflation adjusted) income rose 130 per cent (compared to 11 per cent in the US), real urban income increased 6.3 per cent in 1Q17, up from 5.8 per cent a year ago. Real rural income rose 7.2 per cent, up from 7 per cent. As a result, while real retail sales growth was still fast at 8.7 per cent during the first quarter, it was down from 9.7 per cent a year ago and 10.8 per cent two years ago.
All of this contributed to GDP growth of 6.9 per cent during the first quarter, up from the 6.7 per cent pace during 1Q16. China’s fiscal revenue rose 14.1 per cent YoY in 1Q17, compared to 6.5 per cent YoY in 1Q16, in line with the improvement in overall economy.
A modest tightening bias
A healthy start to the year has provided the People’s Bank of China (PBOC) with an opportunity to tighten monetary policy a bit, but their objective is to reduce liquidity and speculation in the bond market rather than to rein in economic growth.
The central bank pushed up the 7-day repo rate to 3 per cent as of April 13, an increase of 60 basis points from three months ago, in an effort to limit speculation in China’s interbank market. At the same time, there has been no change to the benchmark lending rate of 4.35 per cent. Moreover, as the index for factory gate prices has risen sharply, real borrowing rates have fallen and have been negative since December.
The growth rate of total credit has slowed a bit, but nominal GDP growth has accelerated, leading to a narrowing of the gap between those two growth rates, signaling modest tightening. This is consistent with ongoing, gradual efforts by the government to deal with high levels of debt among state-owned companies.
Additionally, in February the PBOC and regulators for the banking, insurance and securities sectors jointly published new draft regulations to further address risk in wealth management products.