Interpreting China's 5.3% GDP Growth in 1Q24: A Positive Sign?

Decoding China’s 5.3% GDP growth in 1Q24

The primary driver of the 5.3% GDP growth was a robust 6.1% year-on-year increase in industrial production. The cyclical rebound in global manufacturing, led by semiconductors and electronic products, has spurred orders for Chinese companies. Furthermore, China's ambition to attain a high level of self-reliance in semiconductors and cutting-edge technologies like quantum computing is fueling demand for value-added products. During the first quarter, the production of electronic goods surged by 39.5%. Furthermore, high-end technological products such as electric vehicle charging stations and 3D printing equipment also exhibited robust growth, with increases of 41.7% and 40.6% year-over-year respectively.

Export performance exhibited signs of improvement, with a 4.9% year-on-year increase in RMB terms, driven by heightened demand for electric vehicles (EVs), lithium batteries, and solar panels. However, the growth was primarily fueled by an approximately 20% increase in export volume, as average export prices declined. The depreciation of the RMB and lower production costs supported China's exports during this quarter. Nevertheless, the US and European countries have accused China of engaging in dumping practices by exporting cheap EVs, materials, and chemicals, leading to subsequent investigations, lawsuits, and potential trade tariffs. These actions could pose challenges for Chinese exports in the following quarters.

Fixed asset investments also saw an uptick of 4.5% year-on-year in the first quarter, supported by the central government's bond issuance aimed at increasing public investments (Figure 1). Notably, investments in the high-tech industry recorded the highest year-on-year growth rate at 11.4%. This reflects China's recent initiatives to upgrade equipment across 30 industrial sectors, with a focus on reducing carbon emissions, enhancing productivity, and fostering digital economies. Private investment saw a slight improvement from the previous quarter's -0.4% to 0.5%, though it remains relatively low overall. Private investments continue to face considerable challenges, as the current macroeconomic environment lacks clear direction, and investors exhibit a limited willingness to utilise available liquidity.

Figure 1: The surge in fixed asset investment was largely propelled by public funding

Over the past year, we have observed a moderation in consumption growth. In the first quarter of 2023, the services sector played a significant role in driving growth, as China just exited from its zero-COVID policy. Consumers' eagerness to spend was palpable, particularly in March, following the recovery from COVID-19 infections, leading to robust growth in the services industry at 5.4%.

This year, consumption expanded by a slightly lower 5.0%, primarily boosted by the Chinese New Year festivities. Demand for daily necessities such as grain, food oil, and new clothes surged during the first two months. However, retail sales in March increased by a more modest 3.1%, falling short of market forecasts of 4.5%. This shortfall can be attributed to the diminishing festival effects and a high base comparison.

China's consumption landscape has undergone structural changes, with a shift from luxury items to daily necessities and entertainment products. The trend of "eat and play" continues to influence the economy as consumers remain cautious about major purchases amid economic uncertainties and a downturn in the property market.

The property market fails to rebound again

Despite the strong 1Q24 GDP, the property market failed to deliver positive news again and continued to weigh heavily on the economy. In the first quarter, the sales floor space of newly constructed commercial residential buildings plummeted by 19.4%, leading to a significant 15.6% year-on-year increase in unsold housing floor space. This persistent decline in demand for sales has posed a profound impact on both investments and construction activities.

Real estate investment continued its slowdown, dropping to -9.5% year-on-year in the first quarter, down from -5.8% in the same period last year. Consequently, the pace of funding for real estate developers decelerated by 26.0%. Although the "whitelist" project introduced earlier this year facilitated lending access for select high-quality projects, banks generally maintain a cautious stance towards lending to real estate developers.

In the current challenging landscape, banks encounter hurdles in evaluating developers' repayment capabilities and asset quality due to the absence of robust sales demand. This not only hampers the approval process but also dampens banks' willingness to lend. Without addressing demand-side issues, the efficacy of the "whitelist" project's assistance remains constrained.

Deflationary pressure remains a significant cause for concern

The GDP deflator for the first quarter turned negative, with China's nominal GDP at 4.2%. While economic growth is typically measured in real terms, the nominal figure underscores the prevailing weakness across China's economy.

In February, the Consumer Price Index (CPI) rose by 0.7%, largely influenced by heightened consumption during the Chinese New Year festivities. However, as consumption normalised in March, the CPI dipped back to 0.1%. Meanwhile, the Producer Price Index (PPI) decreased by 2.8% in March, marking the 18th consecutive month of decline.

China's efforts to combat deflation have thus far been unsuccessful, falling significantly short of its 2% price growth target. With industrial production outpacing demand, overproduction continues to exert downward pressure on prices. Additionally, China's initiatives to upgrade machinery and invest in higher-end sectors have exacerbated overcapacity issues, further suppressing factory gate prices. In the first quarter of this year, the industrial capacity utilisation rate dropped to its lowest level since the second quarter of 2020 (Figure 2), ranking as the third lowest among G20 countries. Its capacity utilisation rate of 73.6% was far below South Korea’s 102.4%, Japan’s 98.0%, and even the US’s 78.3%.

Figure 2: China’s industrial capacity utilisation rate fell to the lowest since 2Q20

Sector-wise, the utilisation rate for non-metallic mineral products such as glass and cement stands at a concerning 62.0%, representing a year-on-year decrease of 1.9%. Demand has been primarily hindered by challenges in the property industry. As we anticipate that the property market has yet to reach its bottom, the utilisation rate will continue to linger at very low level, exacerbating pressure on excess inventory.

Moreover, the capacity utilisation rate for automakers is the second lowest at 64.9%, particularly in the new energy segment. The emerging new energy car manufacturing industry has attracted players from diverse industries, including smartphone manufacturers Huawei and Xiaomi. However, the influx of competitors has led to oversupply and sparked a price war, intensifying pressure on sales prices.

While increased production capacity is advantageous in the long term when demand is robust, it currently only drags down prices and suppresses investment. This exacerbates the issue of oversupply, further contributing to deflationary pressures. Although stronger industrial and investment levels may buoy growth this year, they also will force China to face a spiral of deflationary pressure driven by both consumption weaknesses and overproduction.

Key risks persist and are poised to become more pronounced

The stronger-than-expected first quarter data has increased the likelihood of China reaching its 5% growth target for the year. Nevertheless, we remain cautious regarding the sustainability of this growth in the coming quarters. The looming issue of deflationary pressures may exacerbate amid weakening consumption demand, posing a significant risk to the economy. Additionally, it appears that China's real estate challenges have yet to reach a bottom, presenting a persistent obstacle that cannot be easily resolved.

Besides domestic challenges, geopolitical tensions pose a growing threat to key Chinese industries, hindering its progress in green transition and high-tech development. Sectors like EVs, renewables, and medical devices have faced increased scrutiny and potential trade restrictions in the US and Europe. Furthermore, Trump holds a significant likelihood of being reelected as the US president, based on polling data. His continued presence in office could pose an even greater detriment to China's trade. In February, Trump already indicated his intent to impose tariffs of 60% or higher on Chinese goods should he secure a second term.

The recent market rally was primarily driven by the fear of missing out on cheap Chinese stocks and speculation on the strengthening domestic stimulus, rather than an improvement in fundamentals. We believe this investing approach carries significant risks, as it often leads to buying on rumors and selling on facts, potentially causing unnecessary panic.

Taking these factors into account, we will maintain our underweight position in China, as the market carries substantial risks with limited upside potential. Our fair Price-to-Earnings (PE) ratio of 10.0X indicates that the Chinese market may offer only a modest upside potential of 2.8% by 2026. Therefore, investors may want to consider reallocating their investments towards markets that could offer more promising opportunities, such as the 'New Asian Tigers' - Singapore, Japan, and South Korea.

Figure 3: MSCI China Index Share Price and EPS Performance

Table 1: EPS and upside projection of the MSCI China Index

Table 2: Recommended products

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.