A fate worse than a hard landing for China | FT Alphaville

A fate worse than a hard landing for China

What IS a hard landing in China?

Well, BAML’s latest survey of fund managers defines it as less than 7 per cent growth. And incidentally, only 8 per cent of those surveyed believe it will happen, half the percentage of the November survey.

However. For something that gets talked about a lot, the definitions of a “hard landing” seem to vary between >4 – 5 per cent and somewhere around 7 per cent.

Here, for example, is S&P:

An intermediate scenario of a medium landing with a 7% GDP increase has a one-in-four likelihood of occurring, while a worst case of a hard landing with a GDP expansion of 5% has a one-in-ten chance.

Nomura’s ‘China Stress Index’, which we wrote about a couple of times, put it as four consecutive quarters that average less than 5 per cent GDP growth.

Gary Shilling defined it as less than 6 per cent this month. And a former PBOC official said late last year that below 7 per cent “means crisis“.

So given that a “hard landing” is bad but a “soft landing” is seen as appropriate and probably a healthy sign of rebalancing towards a higher ratio of consumption to GDP, at which point the two diverge? Seven per cent, after all, is not that far from what some more worried analysts are calling it (though the majority are still closer to the 8 or 8.5 per cent mark).

As far as we can tell, the ‘hard’ bit of a hard landing, for most pundits, denotes some kind of point at which social unrest and/or a recession-style downward spiral of demand takes place. It’s not surprising that definitions of what that hypothetical point might be vary.

For one thing, China’s unreliable data gets in the way, quite, quite badly. As Stephen Green of Standard Chartered wrote to us:

Given slowing growth in the labour market it’s getting harder and harder to work out how many jobs need to be created.

The [government] has limited accurate info on the pace and scale of job creation and destruction.

Some GDP growth is really  job-creating (services), while some is really not (steel and aluminiuim plants), so its all but impossible to work out a crude equation of so much GDP growth equals so many millions of jobs.

So it seems reasonable that the analysts at Nomura, who are attempting to put a number on the odds of a hard landing, have adopted a cautious line. As their Asia chief economist Rob Subbaraman writes:

Our definition of hard landing is naturally subjective. There is no strict academic definition. What we have tried to define is an abrupt downturn in the economy that would be painful enough for the man and woman on the street to really feel it, ie unemployment to rise. We have tried to be conservative in that our definition of a hard landing would be a hard landing with little doubt. The rationale behind our definition are twofold:

Quantity: we know that China’s potential output growth is slowing (in part due to the demographics) and so we wanted to choose a max GDP growth rate that would without doubt be below a slowing potential growth rate, thus causing a severe recession and unemployment to spike. A decade ago it may have been 7% but with potential growth slowing today a max of 5% feels more about right. It would be equivalent to probably -2 to -4% growth in the US.

Duration: one quarter of a bit under 5% growth need not be a hard landing if it is followed by a snap back to, say, 12% growth the next quarter. Hence our definition of GDP growth averaging 5% or less over four straight quarters. It could be four quarters of 5% growth, or one disastrous quarter of, say, -2% followed by 5%, 8%, 9% – averaging 5%. Either a disastrous quarter (or more) or persistently weak 5% growth would, in our view, cause an unemployment problem in China over next three years (note the 1-in-3 likelihood we’ve attached is for the hard landing to commence before the end of 2014).

As the comments above suggest, there is a political and social element to this. If unemployment rises too much, the logic seems to go, the communist party’s authority could be seriously challenged. And then, who knows what it would mean for the banks, or the coddled state-owned enterprises? Or local governments? Or all those infrastructure projects?

We also asked Nicholas Lardy, a Peterson Institute fellow who has written several well-regarded books on China’s economy, for his thoughts on the concept of a “hard landing”. The subject isn’t addressed directly in his latest book, so we emailed him asking whether a deceleration in the apparent growth rate of urban wages (10 per cent on average) would constitute a “hard landing” — or if he believed the term was meaningful (this was without reference to any other particular analysts):

His reply:

I don’t think short term deceleration of wage growth would trigger unrest.  Although wage growth in real terms has been 10%, in 2009 there was little growth for large segments of the modern sector labor force.  But this episode was followed by above average increases in 2010.  But maybe sustained wage growth slowdown would trigger unrest, this hasn’t been test recently.

He goes on to say (emphasis ours):

I don’t like the term hard landing because sometimes users of this term imply that the economy would fall sharply and then quickly bounce back.  I think the greatest risk now is a sustained slowdown lasting a couple of years, perhaps even longer.  If property weakens further it will have widespread macro repercussions, even if there is not initially a strong knock on effect on the financial sector.  So growth over a period of about 2 years might slow to 7% plus or minus and then remain at that low level for a couple of additional years.  That would have major implications not only for China but for the global economy. But this path is not really captured in the phrase “hard landing.”

We’ll leave you with that thought.

Related links:
6 ECONOMISTS ANSWER: Is China heading towards a hard landing? Business Insider
China’s hard landing odds, updated – FT Alphaville
China growth still up in the air – BeyondBrics
Review of Nicholas Lardy’s latest book – FT