China Rebalancing Update – Q2 2014

Nicholas Borst (Federal Reserve Bank of San Francisco)



With all the relevant economic data out, we can now update our rebalancing indicators for the second quarter of 2014:

1. Urban Disposable Income Growing Faster than GDP

The gap between GDP growth and urban disposable income growth expanded in the second quarter of 2014. The gap increased to -0.4 percent versus -0.2 percent in the previous quarter. Given that much of the recent “mini stimulus” has been focused on infrastructure, it’s unsurprising that the uptick in GDP was not matched with an uptick in household incomes. This indicator remains neutral, but it will be downgraded if gap continues to widen.

Indicator = Neutral (3/5)

Figure 1 GDP and disposable income percent growth, year over year (ytd.)

GDP and DI

2. Positive Real Interest Rates on Deposits

The real rate on deposits increased slightly in the second quarter of 2014, from 0.6 percent to 0.7 percent. As in previous quarters, the persistence of positive real rates is driven by low inflation rather than an increase in nominal rates. Inflation in June was 2.3 percent, down from 2.4 percent in March. This indicator remains slightly positive, but remains vulnerable to any increase in inflation.

Indicator = Slightly Positive (4/5)

Figure 2 Real interest rate on one-year deposits


3. Residential Real Estate Investment Growing at a Slower Pace than GDP

The growth of residential real estate investment dropped sharply in the second quarter of 2014. Residential real estate investment growth fell 2.7 percentage points, following a 2.6 percentage point drop in the first quarter. Residential real estate investment is now growing at the slowest rate seen since 2012. The abrupt slowdown in investment growth explains the government boost the housing market by relaxing home purchase restrictions in many cities. Despite the slowdown in growth, housing investment is still growing significantly faster than GDP and therefore this indicator remains negative.

Indicator = Negative (1/5) 

Figure 3 GDP and residential real estate investment percent growth, year over year (ytd.)

RE and GDP

4. Loans to Small Enterprises Growing Faster than Large Enterprise Loans

The growth rate of loans to small enterprises decelerated in the second quarter, dropping from 16.3 percent to 15.7 percent. In contrast, the growth rate for large enterprise loans increased from 8.6 percent to 10.1 percent. As a result, the gap between the two narrowed to 5.6 percentage points. The decline in the growth rate of loans to small enterprises may be the motivation behind Premier Li’s recent efforts to boost lending to small enterprises through targeted cuts to the loan-to-deposit ratio and required reserve ratio. This indicator remains positive, but is in danger of slipping if these trends persist.

Indicator = Positive (5/5) 

Figure 4 Total enterprise and small enterprise loan percent growth, year over year (ytd.)


5. Growth of the Tertiary Sector Faster than the Secondary Sector

In the second quarter, the growth rate of the secondary sector and tertiary sector accelerated by 0.1 and 0.2 percentage points, respectively. The faster growth rate of the tertiary sector means that the gap between the two has now increased to 0.6 percentage points. One of the continued bright spots in the rebalancing story, the tertiary sector has now grown faster than the secondary sector for six sequential quarters.

Indicator = Slightly Positive (4/5)

Figure 5 Secondary and tertiary sector percent growth, year over year (ytd.)


Overall: The prospects for economic rebalancing in China remained slightly positive in the second quarter of 2014, although some of the trends look worse than the first quarter. Disposable income growth slowed despite a strong uptick in GDP growth. Real interest rates remained in positive territory largely due to subdued levels of inflation. The growth of loans to small enterprises slowed modestly, while loans to large enterprises increased. The tertiary sector recovered slightly from the drop seen last quarter and expanded its lead relative to the secondary sector. Real estate investment growth repeated the sharp drop seen in the previous quarter. The slowdown in real estate means that the market may be settling into a more sustainable growth rate. However, a rash of government policies aimed at arresting the decline may reverse this trend.

Overall Grade = (17/25) Slightly Positive

Figure 6 Rebalancing Trend


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