What you need to know about the 2014 outlook for China

January 21, 2014 / By  

I see a contradiction in the outlook for China in 2014 in that optimism is very high but the rhetoric points to slower growth. Optimism stems from the rebound in growth in 2H13 and the expectation of a stronger export sector in 2014 with the increasing strength of the US economy, Abenomics in Japan, and a Eurozone that is finally (barely) out of recession. At the same time, China’s policy makers are trying to implement economic, market and finance sector reforms and reign in credit expansion – policies, which if implemented, would likely reduce the growth rate in the short term. In addition, China’s policy makers seem likely to target slower growth in 2014 than in 2013 and accept a lower floor to growth than what is the likely 2013 full year growth rate of 7.7 or 7.8%.

At this time last year most of our clients were quite concerned about growth in China, seemingly obsessed with risks of a ‘hard-landing’ and very reluctant to make decisions about things like office expansion or relocation. Since mid-2013, the economy has been accelerating and the mood has improved noticeably – barely a ‘hard-landing’ is uttered anymore. While most of our MNC clients remain cautious about moving forward with China growth plans, they are much more willing to make decisions than a year ago. Domestic clients are even more optimistic, particularly in the real estate sector where we have seen some groups turn much more aggressive with land acquisition and development.

Is this optimism warranted?

We expect exports will shift from making a small negative contribution to GDP growth in 2013 to making a small positive contribution in 2014. This could add between 0.3 and 0.6 percentage points to real GDP growth in 2014, all else being equal. But all else is never equal. We expect policy makers to use this growth boost from exports to more aggressively pursue the reform agenda, particularly around reigning in credit expansion and reducing investment in manufacturing and infrastructure. There is also a risk that this will impact China’s housing sector if mortgage availability is more limited and interest rates are somewhat higher as a result of reforms. To be clear, though, this is not our baseline forecast for housing, which we expect to be more stable in 2014 with lower price growth due to increased supply and less pent-up demand.

As a result of stronger exports but assertive policy reform, GDP growth in 2014 could well come in around 7.3% and we would expect economists to once again lower their growth forecasts over the course of the year as more clarity is brought to how reforms are being implemented. On a positive note, one of the most important beneficiaries of the reform agenda will be development of the service sector economy. The service sector is more labor intensive and less capital intensive and it is central to the effort to grow the middle class, increase incomes and move toward more consumption led growth. From a real estate perspective, over time this will be a net positive for the office sector since service sector companies need office space. This will be most apparent in Tier 1 cities which will benefit from special zones like the Shanghai FTZ and Qinhai in Shenzhen. In Tier 1.5 cities oversupply of office space is the larger concern in the short term, but we remain convinced that growth in the service economy will lead to sufficient absorption within 5 years – admittedly a lifetime in real estate terms.

Finally, to repeat something we have been saying since 2011, when we look out to China in 2017 or 2018, it is no longer a 7 or 8% growth economy – it is more likely to be a 5 or 6% growth economy and that will be in a good scenario. We feel relatively few analysts and companies have been reflecting this long-term outlook in their reports, forecasts and planning, but as the reform agenda takes hold many more will. If implementation of reforms are not taken with due urgency, and China is still growing at 7% by 2017, then the resulting risk profile, especially for the credit and banking sectors, will be substantially higher and China’s economy could well be facing a major correction that would have global consequences.

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