Chinese headline data masks underlying economic risks
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China’s government announced last week that GDP growth, once again, came in pretty much exactly where it wanted it to be, actually outperforming expectations by a hair.  

Yet, even leaving aside the farcical nature of Beijing’s economic announcements, investors won’t have to look far for evidence that the Chinese economy is strengthening.  


Fourth quarter results from our firm’s 3,300 company China Beige Book survey, for example, confirm powerful gains over a historically weak fourth quarter of 2015, and a clear improvement over the third quarter of this year as well. 


However, headline numbers for China, even ours, often disguise, rather than reveal, the risks. A deeper look shows the stability many now take for granted for 2017 is still very much up in the air.

The stellar corporate results we have seen the past few quarters probably cannot last. In the fourth quarter, both revenues and profits bounced back strongly from their poor performance a year earlier.

They confirm, for example, the one-year boom in auto sales, transportation construction, and commodities, such as coal and steel. Yet our cash flow data, the most comprehensive available, show an outright deterioration.

Receivables (payments received late) worsened overall and payables (payments made late) worsened in every sector but agriculture. Services, property, transport, and even ostensibly surging retail saw both metrics deteriorate over this period.

Cash flow also offers another angle on seemingly positive trends in corporate borrowing. The proportion of firms borrowing hit a three-year high in the third quarter and stayed close to that level in the fourth.  

Cash flow problems indicate firms may be borrowing to cover shortfalls rather than fund expansion. While deteriorating cash flow is by no means more important than sound profits and revenue, one trend or the other must give way this year and it is not yet certain which one that will be. 

While the tug of war between headline figures and cash flow is the main event, there are other reasons to anticipate instability this year. In the third quarter of 2016, inventory growth was tied for the highest in the history of China Beige Book.  

That record lasted all the way to the fourth quarter, when it was eclipsed by even larger inventory gains. Because China is obviously not a market economy, it can avoid painful destocking for longer periods than other economies. To last the entirety of 2017, though, is asking a lot.

Whether Beijing will try to fight off destocking with yet more pump-priming monetary policy would be an important question any year. It verges on vital in 2017.

Many observers are betting on stability purely on the grounds that instability will not be tolerated in close proximity to the twice-a-decade Communist Party Congress this fall.  

In fact, just this week, the International Monetary Fund hiked its forecast for China’s 2017 economic growth precisely on this basis.

But while the Chinese government and global investors may see stability at present, they do so for very different reasons. Beijing does not care about underlying GDP growth — it can, and does, announce any figure it wants. Beijing cares far more about employment.

In that vein, another recent development was very good for the Party and Chinese workers — after a scary two-quarter stretch a year ago, the pace of employment growth increased throughout 2016.  

The fourth quarter was particularly strong, leaving little incentive for additional fiscal or monetary stimulus in early 2017. This good news is nonetheless unwelcome for global commodities markets hoping for further increasing Chinese real estate and transportation construction. 

A desirable 2017 start for the labor market is even a bit tricky for Beijing. There is no point trying to stimulate now, but if hiring fades in the second or third quarters, a policy response may not work quickly enough. Conversely, it may overshoot, causing a spike in housing prices, for example. 

With China heavily leveraged, the stability the Party desperately wants for 2017 is a solid, though uncertain, bet.

A final issue relates that leveraging to China's international situation. One reason we weigh cash flow and other fault lines as heavily as the reassuring headline growth is due to the fragility of China’s financial markets.  

Last month, a mere quarter-point rate rise by the Federal Reserve, which was long-telegraphed, threw the Chinese bond market into spasms.  

So, while Beijing insists the system is sound and the economy is powering ahead, financial flows say otherwise — money is pouring out of the country and the yuan continues to lose steam against the dollar, despite, by far, the world’s largest merchandise trade surplus. 

Enter President Trump, a pointed threat to that surplus, China’s balance of payments, and, to some extent, it's uncertain domestic financial stability. 

If the environment around them deteriorates, individual Chinese companies will have to run faster in 2017 just to stay in the same place. This could prove a challenge even Beijing cannot meet or hide.


Leland Miller is chief executive officer of China Beige Book International. Derek Scissors is the chief economist for China Beige Book International, as well as a resident scholar at the American Enterprise Institute.


The views of contributors are their own and not the views of The Hill.