Our baseline scenario for the outlook for China’s economy, since at least early Fall 2011, has been steadily slowing growth through the first half of 2012 – the so-called soft landing – followed by strengthening growth in the second half of 2012. We maintain this view, even in light of the 2Q GDP report last week, in which China reported year-on-year growth of 7.6%.
So what is it that gives us confidence that China’s economy will rebound later this year? There are two primary components to this outlook. First, a steady rebound in infrastructure spending since the beginning of the year, culminating in a huge jump in the June data, with a coinciding jump in bank lending. Second, steadily increasing residential transaction volumes since Chinese New Year, driven by first time home buyers. Together, these two components drive demand for large segments of the domestic economy – from heavy industry and manufacturing, to commodities imports, to employment.
The other important thing to keep in mind is that neither of these things has happened by accident. They are both the result of intentional government action. In particular, understanding what’s happening in the housing market, and the stealth easing that has been in process since at least February, is key to the sustainability of the volume recovery. Down payment requirements were brought back down to 30% in the first quarter, and we’re hearing about some small banks now offering 20% down payment home loans. The two interest rate cuts in the last month have helped with pricing as well, with mortgage interest rates having fallen from as high as 7.5% at the start of the year to potentially as low as 5.1% at big banks and, unofficially, 4.2% at small banks for first time home buyers.
With the large amount of residential supply in the pipeline in most cities, we are not expecting developers to achieve pricing power in 2012, and this limits the risk of policy backsliding toward renewed restrictions. The key, though, will be that policies limiting investment purchases remaining in place, and enforced. It is the enforcement part that has led to the constant rhetoric from the Central Government about remaining vigilant about prices. They need the local governments to maintain enforcement of HPRs, which have been effective at marginalising investor demand. This will be a greater and greater challenge as volumes and sentiment improve in the second half of 2012 and investors are keen to once again participate in the market.
So barring a collapse of external demand due to the Eurozone crisis or the US ‘fiscal cliff’, the rebound in infrastructure and housing markets in China will lead to stronger growth in the second half of 2012.
