Data released last week showed that China’s GDP growth accelerated in Q309 to an impressive 8.9% on a year-on-year basis, its highest rate since Q308. This was a remarkable achievement for the Chinese authorities and one which just six months ago many thought would be impossible. With GDP growth averaging 7.7% so far this year, and the recovery expected to gain pace over the coming quarters, the Chinese government appears on track to surpass its 8% growth target for this year.

The further acceleration in GDP growth was not particularly surprising given the continued improvement in activity suggested by other recent data. The manufacturing PMI survey has remained above the key 50-expansion mark for the past seven months, while industrial production, fixed asset urban investment and retail sales growth have remained strong. Looking ahead the Chinese authorities’ commitment to supportive fiscal policy and appropriately loose monetary policy will mean that growth remains well supported over coming months. So while we expect the authorities to monitor carefully the credit boom - new loans increased to CNY1.5tn for the first nine months of 2009, almost twice as high as for 2008 as a whole, while M2 money supply rose 29.3% on a year-on-year basis in September, its fastest pace since 1994 - this should not prevent investment continuing to underpin strong domestic demand and compensate for relatively sluggish external demand (exports were still down over 15%Y/Y in September) over coming quarters.

With domestic demand in the major industrialised countries still subdued, the pace of Chinese demand will be crucial to the strength of the global recovery in the early days. This is particularly true for Japan, where Chinese demand was the driving force behind Japan’s rebound in Q209, with Chinese imports from Japan rising over 30% on the quarter. And with Chinese imports from Japan, Europe and the US in September up around 130%, 50% and 40% respectively since their troughs at the start of the year, Chinese demand is clearly making a meaningful contribution to GDP growth in Q309 in those countries. And looking ahead, with Chinese growth expected to accelerate further over the coming quarters, external demand from China should continue to provide significant support to the global recovery. 

China’s GDP and import growth

Source: Bloomberg and Daiwa Securities SMBC Europe Ltd

From a medium-term perspective, however, there are growing concerns that the recent surge in investment and bank lending could prove to be excessive. Although non-performing loans fell to 1.66% of total loans at end-September, down from 2.42% at end-2008, there are growing doubts about loan quality - indeed, China’s bank regulator has recently warned banks of rising credit risk and urged banks to take quarterly stress tests in order to avoid liquidity risks. So we continue to expect the Chinese authorities to further tighten lending conditions over the coming months.

There is no denying that the policy response from the Chinese authorities has been a resounding success. The timely and substantial fiscal stimulus, as well as interest rate cuts and administrative steps to boost credit lending, have been key to China’s extraordinary resilience in the face of the deepest post-war global recession. And so in contrast to many major industrialised economies, the reputation of Chinese policy makers has undoubtedly been enhanced through the recent credit crisis, for now at least. With few signs of inflationary pressures - although it will move into positive territory, headline CPI is expected to remain contained over coming months - Chinese interest rates will likely be left at low rates for some time. But with the rapid pace of lending expected to continue, asset prices are set to rise further over the coming months – although the equity market is still well off its 2007 high, it has risen over 70% since the start of the year, while property prices increased 2.8%Y/Y in September, its fastest pace in a year. And so the authorities will need to withdraw its supportive measures in enough time to avoid an unsustainable rise in asset prices and prevent bubbles similar to those seen in previous years. We expect administrative measures, including banks’ reserve requirements, to be tightened at the start of 2010. And while we expect the renminbi to be allowed to appreciate very gradually against the US dollar from Q110 onwards, we think the central bank will hold off raising rates until H210. 

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