Focus On China: Domestic Demand Drives Growth

Includes: FXI, PGJ
by: David Goldman

China’s retail sales in September were 18% above the year-earlier total, and retail sales during the January-September period of 2011 were up 17% vs. the same period in 2010, the National Statistics Bureau reported overnight. Although 3rd-quarter GDP growth came in slightly below expectations at 9.1%, domestic demand is gradually replacing the trade surplus as China’s growth driver.

The retail sales data suggest that consumption will rise as a share of GDP this year, reversing the long-term falling trend. Consumption fell to a twenty-year low of 33% of GDP in 2010, while investment reached 50% of GDP. Excess investment is supposedly the main argument for the “hard landing” thesis for China.

These numbers suggest that the Chinese stimulus program has had more or less the effect that Beijing intended: the post-crisis jump in investment has led to an increase in consumption.

Rural and urban retail sales grew by about the same amount, according to the National Statistics Bureau. Between the third quarter of 2006 and the third quarter of 2010, the last for which China’s statistical bureau publish data, the per capita cash income of rural households rose by 76%.

The reduced efficiency of investment in China post-2008 noted by Deutsche Bank and other observers seems to have been a cyclical effect rather than a secular trend. Lower capital efficiency was to be expected after a government-driven surge in investment, but it is not necessarily a permanent feature of the landscape. Chinese profits seem to be improving along with domestic demand. As we noted September 1, industrial profits in July showed a 28.3 percent year-on-year increase, above consensus estimates, and far better than HSBC’s prediction of 10% growth for 2011.