You would think China would not need to exaggerate numbers associated with its startling stimulated investment boom.
But the analysts at Standard Chartered nevertheless present a compelling case for that suggestion — specifically with regards to fixed asset investment.
Fixed asset investment, or FAI, is China’s main measure of capital spending. It’s different to fixed capital formation, or FCF, which is defined as the net increase in fixed assets during a period of time and is the single-largest component of China’s GDP (accounting for some 41 per cent in 2008). In contrast, FAI is not part of GDP but is a main source for deriving FCF, and is therefore often used as something of a harbinger for the welfare of the Chinese economy.
For instance, this story from Hong Kong’s The Industry Standard:
China’s exports and imports declined in May, but this was offset by better-than-expected growth in urban fixed-asset investment – indicating the world’s third-largest economy is well on the road to recovery.
So if China were exaggerating the FAI figure, it would amount to massaging their GDP figures upwards. Massively, perhaps, given the rather dramatic rise in FAI of late. FAI rose 39 per cent in May from a year earlier, growing at the fastest pace since the investment boom of 2004 according to the WSJ.
In any case, here’s Standard Chartered on the FAI:
. . . is recent FAI data being exaggerated? We think so. There is certainly no shortage of incentives these days for massaging up this data as all local officials have incentives to report good-looking numbers. Some analysts have argued that the cost of land purchases has been the main driver of higher FAI growth. However, land costs are measured as ‘others’ in the breakdown of FAI, while it is construction FAI that has led the overall surge . Rather, we suspect that planned spending is finding its way into today’s numbers in order to prove that things are being done now. Why do we say this? Three reasons:
1. The abnormal increase in the FAI ‘completion rate’ this year does not look right to us. The completion rate is defined as the ratio of fixed assets that have been completed and put in to operation to the total FAI during the period, and is also reported by local governments. As Chart 8 shows, the completion rate rose in the first five months of 2009, to 34%, from an average of 26% in the last five years. One possible explanation is that on-going projects got a sudden boost of funds and urgency after the roll-out of the stimulus policy, resulting in the speed of construction increasing by some 30%. Another possible explanation might be a wave of M&A deals, which would push more unused assets into use. But this seems unlikely — and we lack data on the number of M&A deals.
2. The People’s Bank of China’s 5000 Principal Industrial Enterprises Survey suggests that more firms are cutting than increasing investment. As we show in Chart 9, its investment index fell by 11.3% y/y in Q2 2009, and during the same period, firms’ profitability also fell by 9.4%. This is largely consistent with what we see on the ground. So it seems strange to us that official industrial FAI rose 30% y/y in real terms as of March (the latest data we have on real FAI growth). Perhaps this is driven by M&A, but if this is the case, it would not translate into GDP growth.
3. . . . construction FAI picked up strongly in Q4 2008, but we had to wait until Q1 2009 for the production of cement and steel to increase. There may have been a small inventory draw down going on, but given that production growth of cement and steel products had been falling more sharply than FAI growth previously, we doubt inventories were that high.
If accurate, Standard Chartered’s reasoning might go some way towards explaining the recent curious divergence between FAI and Chinese imports.
It might also suggest that if China’s exaggerating the FAI numbers now, then a larger portion of the FAI will not find its way into GDP figures later.
Related links:
Chinese liquidity and stocks go BOOM! – FT Alphaville
Investment up over 30%, imports down 25% – Brad Setser
Wanted: Superhero to save the world – FT Alphaville
China’s fake recovery - FT Alphaville