China’s recent economic numbers have hardly been impressive so far. GDP growth came in at 7.6% year-on-year, the slowest pace since the depths of the global financial crisis in 2009. Foreign direct investment dropped 8.7% from a year earlier in July to reach a two-year low. Manufacturing activities and exports are not looking pretty either. And if the Purchasing Managers Index (PMI) and bank loan performance thus far are signs to go by, things would appear to remain relatively tepid on the Mainland for a while.
With these headlines hogging the news, some investors might understandably turn more cautious and be inclined to adopt a wait-and-see attitude. Worse still, some may even end up misreading the implications and drawing the wrong conclusions during a period which is just as dynamic as ever. At risk of sounding cliché, China is a massive country with different regions at various stages of development. Given the intensification of complex changes unfolding across the country, it is imperative that investors dig deeper below the surface than ever before to separate effects of cyclical headwinds from enduring structural changes.
As a case in point, grade A office rental growth in Shanghai has indeed been moderating as economic growth decelerates (Chart 1). However, unlike the previous episode when rents corrected sharply without much lag, Shanghai’s CBD office sector has been noticeably more resilient this time. Rental growth only peaked more than a year after economic growth did. In addition, rents are still growing even after economic growth has fallen below double-digit territory for six quarters. This contrasts sharply with end-2008 when rents contracted as the economy slowed beyond the 10% threshold. While differences in the nature of economic slowdown during both episodes played a part, they do not sufficiently explain the observed resilience in Shanghai’s office sector; especially with the relatively larger supply pressure in the current cycle (Chart 2).
Chart 1: A more resilient Shanghai office rental market now
Source: CEIC, Jones Lang LaSalle Real Estate Intelligence Service 2Q12
Chart 2: Relatively larger supply pressure in current office cycle
Source: CEIC, Jones Lang LaSalle Real Estate Intelligence Service 2Q12
A stronger explanation lies in Shanghai’s evolving economic growth engine coinciding with the period of observed rental resilience. Chart 3 illustrates how Shanghai’s services sector has been defying broader growth trajectories for almost two years now. Clearly this is hardly a blip and other forces are behind this divergence. Efforts by the State Council to develop Shanghai into an international financial centre and shipping hub have provided the impetus to help provide some offset against cyclical headwinds besetting other segments of the economy.
Chart 3: Shanghai’s services growth diverging from broader trends
Source: CEIC
Shanghai’s grade A office sector aside, various other structural changes are rapidly unfolding across China even if they are obscured by headline numbers. The inner and western regions are powering ahead, growing at up to double the growth pace of coastal regions. For the slowing coastal cities, the services sector is still recording healthy foreign direct investment growth while the non-manufacturing PMI indicates continued expansion. Given the ongoing changes in China’s economic fabric, bottom-up analysis is becoming increasingly more important. GDP remains a blunt measure of development and there is no need to get overly disappointed with lower Mainland growth just yet.
