China’s 4Q GDP growth slowed to a ten-quarter low of 8.9% y-o-y, slightly better than expected. On an annualized sequential basis however, growth dropped sharply from 9.2% in 3Q to 8% in 4Q (seasonally-adjusted), signaling further slowdown to come in the coming quarter. Despite the upside surprises in December’s IP and retail sales growth, investment decelerated faster than expected. All this calls for more steps towards easing. We continue to expect at least 150bp worth of reserve ratio cuts in 1H 2012, with the next one coming within a matter of weeks.

Facts

China’s economic growth slowed to a ten-quarter low of 8.9% y-o-y in 4Q from 9.1% y-o-y in 3Q 2011. The result was a touch higher than our and market expectations of 8.6% and 8.7% respectively. Seasonally adjusted, q-o-q growth eased to 2.0% in 4Q from 2.3% in 3Q, as 2011’s full year GDP growth slowed to 9.2% y-o-y from 10.4% y-o-y in 2010. Broken down, 54.2% (or 5ppts vs. 5.6ppts in 2010) of this was attributed to investment, 51.6% (or 4.7ppts vs. 3.8ppts in 2010) to consumption and negative 5.8% (or -0.5ppt, vs. 0.95ppt in 2010) to net exports.

By sector, the acceleration of output from primary industries (4.5% y-o-y in 2011 from 3.8% y-o-y in the first three quarters thanks to a good harvest) failed to offset the moderation of output from secondary industries (10.6% y-o-y in 2011 from 10.8% y-o-y in the first three quarters) and services industries (8.9% y-o-y in 2011 from 9% y-o-y in the first three quarters).

The slight upside surprise in 4Q’s GDP growth print was boosted by a pick-up of December’s industrial production (IP) and retail sales growth ahead of an early Chinese New Year. That said, investment did not see a similar boost, registering a faster than expected slowdown.

IP growth jumped to 12.8% y-o-y in December from 12.4% y-o-y in November, beating consensus (12.3%) and our forecast (12%) by a notable margin. This translated into a 1.1% m-o-m growth rate, better than 0.93% m-o-m in November (seasonally adjusted). The rebound was driven by heavy industries, whose growth surged to 13% y-o-y in December from 12.4% y-o-y in November, adding 0.4ppts to December’s IP growth. Growth of light industries meanwhile edged up to a pace of 12.6% y-o-y in December from 12.4% y-o-y in November.

By product, reflecting the acceleration of heavy industries, electricity growth rebounded to 9.5% y-o-y in December from 8.5% y-o-y in November; but steel production dropped 6% y-o-y in December from 7.8% y-o-y in November and cement production plunged to 7% y-o-y in December form to 11.2% y-o-y in November, and cars contracted by 6.5% y-o-y in December from 1.3% y-o-y in November.

Retail sales growth jumped to an eleven-month high of 18.1% y-o-y in December from 17.3% y-o-y in October, beating our above consensus forecast (HSBC: 17.5%, Consensus: 17.2%). Thanks to easing inflation, real growth of retail sales growth picked up to 13.8% y-o-y in December from 12.8% y-o-y in November. Seasonally adjusted, December’s m-o-m growth rate jumped to a 2011-high of 1.41%, compared to 1.28% m-o-m in November. The breakdown suggests a notable acceleration (3-5ppts) of both staples and durables (except cars) sales ahead of the Chinese New Year.

Fixed asset investment growth (FAI) decelerated sharply to 23.8% y-o-y for the whole year 2011, compared with 24.5% y-o-y for the first eleven months and 24.1% of market expectation. As such December FAI growth dropped to a four-year low at 19% y-o-y from 21.3% y-o-y in November, translating into a second consecutive contraction of 0.14% m-o-m from - 0.41% m-o-m in November (seasonally adjusted).

The FAI slow down was mainly driven by a sharp deceleration of real estate investment, whose growth decelerated to 27.9% for the whole year of 2011, compared to an average growth rate of 29.9% y-o-y in Jan-Nov. This implies a sharp drop of December real estate investment growth to 12.6% y-o-y from 20% y-o-y in November. Within this, residential property investment slowed to a pace of 30.2% in 2011 from 32.8% y-o-y in Jan-Nov from. Moreover, the property sales growth contracted for the third consecutive months, bringing the whole year (2011) property sales growth to 4.9% y-o-y. Separately, the contraction of newly started property investment weighed on the growth of newly started investment projects, which moderated to 22.5% y-o-y from 24% y-o-y in Jan-Nov.

Implications

China’s growth slow down, widely anticipated by both the market and us, reflected the continued cooling of domestic demand in response to Beijing’s earlier tightening measures (on both the credit and property fronts), as well as the recent weakening of external demand. The pace of this slow down remains under control, and in much better shape than the sharp deceleration (to as low as 6.6% y-o-y in 1Q 2009) during the 2008-09 financial crisis. However, the significant drop in the annualized seasonally-adjusted growth rate (from 9.2% in 3Q to a three-year low at 8% in 4Q) suggests that growth momentum remains weak, signaling further slowdown to come in the coming quarter.

The upside surprises in December’s IP and retail sales growth were likely boosted by the early arrival of the Chinese New Year holiday this year (January 2012 vs. Feb 2011), when factories are typically closed for at least a week (23 January) and people ramp up shopping for celebration and holiday. Monthly y-o-y growth data points will thus likely yield lower numbers in January and possibly in February when the holiday ends.

Overall, despite some initial signs of stabilization, China’s slowdown has yet to be fully reversed.  Where GDP growth is concerned, we expect things to get worse before they get better. That said, a hard-landing should be avoided even with 1Q’s GDP growth prints set to slow further to around 8% y-o-y (by our forecast), as this quarter should mark the bottom of the current downturn cycle.

This sluggish pace of moderation can be blamed on the ongoing weakening of external demand – which we expect will drag China’s exports growth rate down towards a single-digit pace in the coming months (from around 13% in December). A total collapse is not expected however, as global growth is not expected to slip into an outright recession within our current base scenario. Property-led investment and its associated impact on industrial production will likely continue for a while longer as Beijing’s property tightening agenda is unlikely to be relaxed any time soon.

Although risks to China’s growth remain titled to the downside in the near term, our view of a soft-landing is secured by the fact that Beijing has sufficient room to ease policy on both the monetary and fiscal fronts to stabilize growth and revive the economy – especially with inflationary pressures now in decline (See China: Inflation still on track to ease further, published 12 January).

>On fiscal front, Beijing’s strong fiscal position (more than RMB10trn tax revenue plus RMB2.6trn fiscal deposit at end-2011) should allow further tax cuts and a redoubling of fiscal spending on public housing, ongoing infrastructure projects, and social welfare.

>On monetary front, we expect more quantitative easing via at least another three reserve ratio cuts (totaling 150bp) in the coming six months, and a 25bp rate cuts once inflation drops to below 3% towards the middle of the year. The next reserve ratio cut is likely just around the corner in view of the seasonal liquidity stress ahead of the Chinese New Year and the sustained sizeable capital outflows (as suggested by recent first ever quarter-on-quarter decline in China’s foreign exchange reserves in 4Q of USD 20bn). Easing credit conditions will be central to ensuring a stabilization of both investment growths, which still remains China’s top growth driver.

Signs have emerged of late that Beijing’s recent quantitative easing measures are starting to work (see the stabilization of PMI readings and the meaningful rebound of monthly new loan over the course of 4Q 2011). As long as easing measures continue to trickle throughout the economy to fuel growth of economic activities, GDP growth should start to rebound to levels above 8.5% y-o-y starting from the second quarter. We remain comfortable with our forecast of 8.6% GDP growth for 2012.

Bottom line: China’s ongoing slowdown will likely take GDP growth to around 8% in 1Q. That said, fading inflationary pressures currently provide more than enough room for further policy easing. China should avoid a hard-landing provided the full impact of monetary and fiscal easing measures continues to filter through the coming quarters.

Chart1. GDP growth slows

Chart2. IP growth to slow further despite the rebound in December

Chart3. FAI slowdown driven by weakness in property market

QU Hongbin -Co-head of Asian Economics Research
SUN Junwei - China Economist