Brief Follow Up to NPL’s in China

In case you missed it, I had a piece on FT Alphaville about the amount of bad loans in the Chinese banking system.  The key take away is that banks are recording 3.7 times the amount of revenue that firms report paying in interest.

One astute reader pointed out some of the discrepancy could stem from the capitalization of interest  in large investment projects specifically in the real estate industry.  This is a reasonable and valid question but one that does not impact the results.

  1. Firms can capitalize interest and count it as the cost of goods sold in certain cases. However, the cases are limited to cases where there is an extended construction or manufacturing period.  Let me give you a couple of examples.  If a real estate developer is building an apartment building for two years and they will sell the apartments in the third year, while the building is under construction for the first two years they count the accruing interest into the cost of the building.  However, during the third year after the building is complete they must count any additional interest accrual is a financial cost.  Another example, a steel mill decides to build a new plant and it takes two years to build.  During the two year construction phase, they can capitalize the interest charging it to the cost of the building.  A key point here is that when they move in and begin production they have to count the loan for the building as a financial cost. If the firm uses or holds the asset they should charge interest as a financial cost.  One final example, a t-shirt manufacturer takes out a line of credit on Monday manufacturers t-shirts all week and sells them on Friday and pays of the line of credit.  The t-shirt manufacturer cannot capitalize the interest expense and count that under the cost of goods sold.  This should be a relatively limited exception.
  2. The data that I have covered here both in listed and unlisted firms goes well beyond real estate. From the listed firm data, the real estate sector comprises 15% of total liabilities and the industrial dataset covering nearly 378,000 firms does not even cover the real estate sector.  This covers lots of in garment, chemicals, tobacco, and publishing but not the real estate sector.  What is notable about this is that most firms across sectors demonstrate a similar pattern.  Publishing, printing, and media topped out at 2.6% financial cost as a percentage of liabilities for the full year ending 2014.  7% for textile and garment firms.  2.4% for pharmaceutical manufacturing.  1.9% for liquor beverages and tea.  In other words, this pattern is not in any way unique to capital intensive firms.  These are firms that should not be capitalizing interest and should be recording higher financial expenses.
  3. Let’s take it one step further. Even if every new loan was 100% capitalized for three years because it’s a big new construction project, that would still imply that the bank was receiving 5.5% in interest payments and capitalizing 2.3%. for the total 7.8% that they report. That still leaves a significant discrepancy between the 2.1% firms report paying and the 5.5% they would be paying.  In other words, even if every new loan is capitalized for three years more than enough for the vast majority of projects, that would leave a very sizeable discrepancy between what firms should be paying and what they report paying.
  4. With all of that said, I actually believe most firms with bank agreement are capitalizing the interest costs adding to the principal balance. However, that is not a good thing.  Basically, they are building up the amount of money that they must pay but can’t because they simply aren’t generating the cash flow necessary to pay the balance.  I believe this actually partially explains why the bank reported interest income as a percentage of loans outstanding is a relatively high almost 8%.  The base corporate lending rate in China should be lower but if interest is being capitalized into the principal, recorded as revenue, this would explain part of that amount.
  5. Even if interest is be capitalized increasing the loan balance, this is simply rolling over the debt into more unsustainable levels. It goes against all accounting principles that this much debt should be counted under the cost of goods sold.  Neither scenario is positive.

Recapping the Weekend in China

  1. Here is video of the press conference of the PBOC announcing its rate cut and reserve cut with an explanation of their view of the Chinese economy.
  2. The clear explanation for the IR and RRR cuts is that the Chinese economy is much weaker than what official data reports. In 2014, official real GDP growth was 7.3% and is on target to come in at 6.9-7.0% for 2015 according to official data.  In less than 12 months the PBOC has cut interest rates six times from 6% to 4.35%.  In any economy, an annual drop of 0.3% is little more than a rounding error or global economy fluctuation. To put this in a different perspective, China has cut interest rates almost 2% due to a drop in the GDP growth rate of about 0.3% during a period of admittedly slow global growth.  Imagine if every country cut interest rates almost 2% for every drop in GDP growth of 0.3%.  Most countries have bigger fluctuations than that every year.  To believe the Chinese economy is even close to 7%, you must believe they are aggressively cutting rates to bring them back up to 7.5-8%.  The Chinese economy is simply not close to 7% GDP growth.
  3. There is no such thing as “weak 6.9%” growth. By weak growth people must have some point of reference as to what makes 6.9% growth weak.  It is not weak in absolute terms as it would still be one of the strongest rates of growth in the world if true.  It is not weak in relative terms as last years growth was only 0.3% higher than this years expected growth.  Even against the past few years, this would represent a slowing of the growth rate by less than 1% of GDP growth.  Economic growth numbers measure a discrete value.  By that I mean than 2% growth is 100% more than 1% and that 3% is three times 1%.  This does not mean that 2% is some fuzzy amount more than 1% or that 3% is different from 1% as black is different from white.  People that say Chinese GDP growth is a weak 6.9% are really revealing they don’t have the intellectual honesty or courage to say they don’t believe official data.  There is no such thing as a weak 6.9%.
  4. As much as the PBOC has been loosening via RRR and IR cuts, this money has largely left via capital outflows. There is definitely some correlation and some causation, but the relationship is undeniable.  It should come as no surprise that capital outflows while they had been picking up, really gained steam when the PBOC began cutting RRR and IR almost a year ago.  This fits very closely with what we would expect theoretically.  As interest rate decline, capital is going to leave the country.  Unfortunately, the PBOC finds itself in a vicious circle now.  The more the PBOC cuts RRR and IR, the more capital is going to leave the country.  Just to keep liquidity stable, it is going to have to cut more, and the cycle repeats.  It should come as no surprise that as every half percentage point cut to the RRR releases an additional approximately $100 billion.  Since the PBOC began cutting the RRR by 2.5% in total since January or 2% excluding the cut on Friday, FX reserves have dropped by approximately $300 billion or roughly 75% of the value of released cash. Add in small time lag and we are witnessing essentially 100% of RRR cuts leave China.
  5. The regular interest rate cuts are driving China closer everyday to breaking the RMB/$ peg or imposing very strict capital controls. China simply cannot move interest rates down and not expect profound pressure on the peg.  This leaves only two options: float the RMB or impose strict capital controls.  So far China seems to have a fuzzy soft policy on both accounts.  They appear to be quietly but gentling tightening capital controls and while they are using large amounts of capital to defend the RMB.  Right now their basic strategy appears to play for time and hope the laws of economics and market pressures go away.  I don’t think this is a solution to the exchange rate problem.  I don’t think you can rule out that there is serious disagreement on these issues at the highest policy levels in Beijing that is causing some of the policy confusion that we see.  It is distinctly possible political bureaucrats with less of an understanding of economics are hoping that policy making by fiat works in international finance as well domestic matters.  The PBOC has smart guys who knows where policy is being pushed by the continual lowering of interest rates but they are subservient to Beijing and will execute the political commands.
  6. Lowering interest rates is absolutely the right policy and in fact, they probably should be lower. PPI is nearly negative 6% and CPI is under 2% at 1.6%.  With interest rates above 4% and borrowers mostly paying above 6% these are corporate real rates at almost 12%.  There is no reason interest rates should be so high except to maintain the peg.  In other words, China is strangling its own economy to maintain exchange rate stability.  With all that said, do not expect a change in interest rate or exchange rate policy any time soon.
  7. I have heard recent jokes about the giant ball of money that rolls around China pushing up different asset prices. It’s a joke but there is definitely some truth to it.  Let me explain.  For many years, Chinese money growth has been well in excess of GDP growth.  Due to capital controls,  money creation remained in the country and drove up asset prices.  Whether it was bank loans, factories, or homes, asset prices exploded.  It comes as no surprise that money used to sterilize trade balances hits the banks and causes lending to increase well in excess of nominal GDP.  On the real economy side, so much money leads to overbuilding and deflation as firms underbid each other to try and stay afloat.  In the financial economy, asset prices inflate as money is essentially trapped and the ball of money simply moves between asset classes.  Due to the capital controls and lack of investment options, there is essentially a giant ball of money that moves between major assets because it can’t go abroad easily and investment fads can easily fall out of favor.
  8. Over the next few weeks I plan to write a number of posts about GDP figures by industry as I think there is a lot more complexity that needs to be explored. Right now I can’t because firm and industry data hasn’t been released for third quarter which should make you pause: national GDP has been released but firms aren’t even reporting third quarter data yet and industries haven’t even reported output data yet.  However, at this point what is most interesting is how certain sectors of the economy either match or don’t match the reported data.  Early data indicates that it isn’t what you think it is.
  9. I am less optimistic about the impact releasing the deposit rate is going to have financial liberalization. Not because I don’t think it is important, it is but because bank managers have already done this.  While official deposit rates are capped, bank managers know and will tell you that any potential client walking into their office with a large potential deposit will always ask what the manager can do for them.  There are a variety of benefits that bank managers can provide to potential clients in place of offering higher deposit rates.

Official Data Doesn’t Reflect Any Underlying Data

As the slowdown is so widely acknowledged, perma-pandas now focus on service sector and consumption growth to meet the 7% growth target.  Given the relative lack of data covering the service sector, some have taken to using the non-manufacturing purchasing manager indexes produced by both the Chinese National Bureau of Statistics and the Caixin version for better information.

As with most Chinese data these days, there are increasing discrepancies between the official and unofficial measurements.  There is typically in recent months about a divergence of approximately 3 points between the official and unofficial measures.  There has however been no analysis as to what is causing the divergence.  The reason for the divergence after even a cursory review is readily apparent.

The official NBS non-manufacturing PMI is comprised of nine different components.  There are some rather unique characteristics that raise the question of political influence over the PMI but also how we can interpret it in light of the questionable construction.

First, of the nine individual components used to construct the official non-manufacturing PMI, only one component in the past year is ever above the monthly average.  It seems rather problematic as an accurate representation of the service sector that one measure would swing a multi-component by itself.  While he measure may provide useful information by itself, it seems to skew our understanding of the health of the service sector by relying so heavily on one component.

Second, not only was the Expected Business Activities Index an outlier, it was an extreme outlier.  The average of the Expected Business Activities Index was 59.9 over the past 12 months while the non-manufacturing PMI was only 53.8.  In other words, it was on average 6.1 points higher than the average.

Third, even given the extreme outlier nature of Expected Business Activity, it still required underlying statistical manipulation to meet the headline number.  This was accomplished by overweighting the one variable that was above the average even by so large an amount.  Though we can’t know exactly how they weighted all nine components, if we take a simple model where all other eight components are weighted identically and Expected Business Activity is overweighted, we can arrive at a plausible estimate.  Using this simple technique, I find that Expected Business Activity would receive a 36% weighting with all other components receiving an 8%.  In other words, Expected Business Activity is 4.5 times more important than any other variable.

Fourth, what makes this specific variable all the more unique in this context is that it does not measure actual business activity but rather the expectation of future business activity.  In fact, if we look at specific measures of business activity, the index tells a decidedly different though not depressing picture.  Over the past year, new orders, new export orders, and employment all hover right around 50.  The In Hand Orders Index is actually beneath that at 44.7 meaning there may be a difference between reported new orders, completion, and shipping to customers.

Given the problematic nature of the official service PMI index, I now turn to placing this in the larger context and what information this can provide us.  First, if we exclude the extreme outlier or use a straight average, the official PMI comes much closer to matching other data points.  For instance, it is much closer to the Caixin Services PMI of 50.5 compared to 49.3.  The difference is now -1.2 compared to 3.7.  Furthermore, it comes much closer to matching broad revenue growth in service sector industries which has been in the low single digits.  Despite the perma-panda argument that services are compensating for the decline in industry, a revised non-manufacturing PMI would actually match rather closely the revenue and consumption growth we are seeing in the tertiary sector.  In other words, if we correct for the official service PMI discrepancy, it comes much closer to matching other data points.

Second, I actually don’t want to rule out the very distinct possibility that the future expectations number is an accurate measurement.  It is such an outlier as to warrant some skepticism and the underlying weighting manipulation is undeniable, but the belief in future growth I think may be reasonable.  Unlike Americans near psychotic belief that everything will always improve with hard work, the version with Chinese characteristics is that people have become so accustomed to rapid growth that they don’t even entertain the possibility that any investment will yield less than 15%, sales won’t go up by at least double digits every year, and jobs will continue to increase.  That is not hope in the future but the undeniable birth right expectation that students and business owners have.  While this brings a host of other problems including risk management and the weight of expectations on political leaders, that is the state of belief.  Consequently, I do believe this could very well at least be close to an accurate measure.

Third, these PMI levels generally match what we know about  revenue growth of both listed and unlisted firms.  Revenue growth in broad and narrow sampling is flat to small declines on a year over year basis.  Despite outlandish and ill informed propositions that the 50 PMI only represents  “dividing line not between growth and recession, but between accelerating and slowing growth.”  50 does represent the dividing line between expansion and contraction as can clearly be seen on the Caixin releases and recognized the world over as the dividing line between expansion and contraction.  In short, these adjusted PMI levels come close to matching both other PMI measures and revenue growth.

Manipulating weightings or underlying data is actually a common technique to manipulate official data because most people do not actually verify the components or internal weightings.  Weighting problems manipulation are common in Chinese data.  In one notable instance, official data uses an 80/20 urban/rural weighting on CPI for China beginning no later than 2000 even though it was almost 70% rural at the time.

People who fail to actually study Chinese data remain convinced that the only variable Chinese data critics use is electricity consumption. As someone who works with Chinese data, the problem is that it is just too easy to point out the glaring manipulation of data.  It isn’t crazy techniques, other data, or conspiracy theories that reveal official Chinese data to be riddled with holes but Chinese data itself.

Note: The data used as always is transparent and available here. Next week I will do a more thorough analysis of GDP and just how manipulated it is.

Quick Thoughts on Today’s GDP Release

  1. China takes the three bears approach to GDP announcements. “7.2% is just too high a no one would believe us. 6.5% is just too low and would cause concern about our economic stability. 6.9% is just right. Not too hot and not too cold.”
  2. Based upon all the underlying data that I have gone over, I just have absolutely no idea how 6.9% was achieved. I know I am considered a real skeptic of Chinese data but I always try to reset my ideas and approach it clear.
  3. Official retail sales YTD YOY were up 10.5% hitting survey estimates exactly. It is very difficult to see how this number was obtained.  As I have covered previously, we simply do not see at the firm level any evidence of a retail market growing at 11%.  Even if we look at output of consumer products from electronics to garments to durable household products, we simply cannot reconcile the granular data with the topline official data.  I should note that even as Alibaba grows relatively rapidly, it comprises too small a percentage of the entire retail space to make up the difference.
  4. Electricity growth was up 1% YTD YOY which given what we know about growth in the service sector, should be taken with a healthy growth of skepticism. As the FT EM Squared group notes, financial services and specifically money center banks are responsible for almost all the growth in services.  The reason this matters is that bank lending goes overwhelmingly to shrinking industries by some measures nearly 90% of lending.
  5. Even the industrial production numbers up 6.2% YTD YOY seem disturbingly high. Based upon what we know about both output and revenue of industrial and manufacturing firms, this number seems stretched at best and patently false in reality.  These numbers among other gems include the statistic that manufacturing is growing at 7%.  On top of the wealth of data covering output and revenue, I can say unhesitatingly that from my own experience in the manufacturing heartland, no one on the factory floor of the world in Guangdong would say growth is 7%.
  6. As the ever astute Simon Cox has pointed out, nominal GDP was actually only 6.2% meaning that the GDP deflator turned negative. This is vitally important for a couple of reasons.  First, implies the producer price deflation is spreading to the broader economy.  Even though officially CPI is still positive at 1.4%, there is significant downward pressure on that number and little evidence that it will be increasing any time soon.  Second, this means that revenue or the nominal side of the economy is not nearly as positive as perma-pandas describing.  Though the data I have shown here is much lower than 6.2% looking at revenue, this does fall broadly inline with the analysis that nominal growth is anemic.  Third, this is all the more worrying for a debt reliant economy.  While most people choose to use a debt to GDP ratio to compare whether an economy is facing credit stress, for numerous reasons this is a somewhat blunt instrument.  However, if we look at changes in firm revenue and liabilities, we get a disturbingly different picture.  Firm revenues for A-shares for instance, have essentially been flat for almost 2 years, but liabilities during that time have gone up by 15% annually and continue to rise at approximately that rate.  In other words, the credit problems of firms who must pay in cash not GDP credits, is worsening much faster than the more widely used official debt to GDP ratios.
  7. Service growth was boosted enormously in Q2 by the enormous increase in financial services from the stock market bubble. Given the collapse in the Chinese stock market in Q3, by almost any measure such as price level, margin lending, or trading volume, it seems shall we say puzzling that service growth remained so robust.
  8. One of the key factors in China’s growth is their decision to simply explode the money supply. M2 growth was more than twice nominal GDP.  This is further pushing credit among other issues.  One of the many but under explored reasons that explain GDP growth in China is the sheer explosion of the money supply.  Next to serial inflators, China is maybe the biggest money creator.  Despite the narrative that China is moving away from a credit orgy of fixed asset investment towards a service driven economy, nothing is further from the truth.  New loans grew 31% through Q3 in 2015 and most of that was old industry firms as I have already covered.  This is not the sign of an economy restructuring, this is the signs of a desperate economy trying to maintain any semblance of growth.

Despite official continued insistence, this is not a healthy economy.

What is the Chinese Services Sector?

As I have covered here many times, the entire claim that the Chinese economy is growing at 7% and of a remotely successful rebalancing depends on the argument that the Chinese service sector is expanding rapidly enough to offset the widely recognized decline in manufacturing and industry.  However, when people discuss the services sector, most especially with regards to China don’t understand one important service sector component and the implication of one component that is recognized as a service sector component.  I should note I plan to do a much longer post on this with lots of data for comparison but  for the moment just give a short sample.

The first mistake people in discussing the “service” sector is not realizing that real estate is included in the so called service sector.  In must be emphasized that this is standard the world over and not in any way unique to China but many people do not realize that when they talk about the growth in the “service sector” they are including very hard production and the upstream industries in this classification.

The second mistake is in how we understand an industry that while recognized and appropriately classified as a service industry has a very large caveat due to “Chinese characteristics”.  Financial services are widely recognized as a service but there are two important factors which imply we should at least recognize the unique nature of arguing for a healthy economy due to service sector expansion.  First, financial services still derive the vast majority of employment, assets, and revenue from the major SOE commercial banks.  Second, these banks give out the large majority of their loans, by some measures almost 90%, to old industry firms that are facing large declines in revenue.  In other words, the financial services industry growth has come from the credit boom of traditional banks channeling money to old industry firms.

As the Financial Times EM Squared team notes, if we strip out financial services from the tertiary sector, services have actually declined since 2000 and relatively significantly by probably at least 5% of GDP.  Even if we look at other services, service sector contribution to GDP  excluding finance is near all time lows.  In other words, any rebalancing has come from the service sector feeding capital to old industry declining firms not from the growth of new firms or organic growth in services.

The numbers bear this out.  While listed A-share operating revenue for financial services and real estate has grown 17% and 31% annually for the last three years, wholesale and retail operating revenue grew at a mediocre 4% annually over the same time period.  That is the complete opposite of rebalancing.

I want to strongly re-emphasize that there is nothing here out of the ordinary in how things are classified officially.  What does need to be recognized are what exactly is considered a service sector industry and their dependence on old declining industries.  If we account for that, the picture looks decidedly different.

Thoughts for a Tuesday on Deaton, Lazy Analysis, and the Bifurcated Chinese Economy

  1. Angus Deaton of Princeton won the Nobel Prize in economics for a variety of high level works spanning a variety of subfields though probably best known for his work on poverty and development. One of the aspects that I believe getting lost in the congratulations being directed at Prof. Deaton is something he excelled at that is fundamental to any economist but so frequently overlooked.  Deaton pioneered many of the data collection and comparison techniques that are so widely taken for granted.  Not content with basic data on per capita GDP, he conducted household surveys and focused on other measures such as consumption that would better inform us about the state of world’s poor.  I feel in many ways indebted to Prof. Deaton studying the Chinese economy by urging people to look at other variables and how closely this matches the public proclamations of official growth.
  2. A lot of China analysis has or is becoming incredibly lazy. Whatever issue or problem arises just insert “anti-corruption and slowing growth” and the analysis is complete.  The most recent example was a news piece from Bloomberg about a sausage maker who is unable to make a bond payment because its director was put under house arrest.  There are a number of issues to note.  First, a food maker is the definition of low risk in something that people will be buying in boom times and in recessions.  Business cycles should have virtually no impact on the underlying business of a sausage maker.  Slow growth is simply not a good explanation.  Second, the supposed house arrest explanation is dubious at best with no details.  For instance, as Bloomberg notes, even the company says it has not received any documentation about the supposed legal entanglements but this is provided as the explanation by Bloomberg about potential default.  Third, despite brief financial figures including a 400 million RMB first half loss and 1.4 billion bond repayment due October 18, Bloomberg relies on the well worn anti-corruption and slowing growth.  This story as do many others seem to require significantly more detail and portend significant credit risk on the horizon.
  3. I am increasingly believing in the bifurcated Chinese economy. A small percentage of the overall economy is doing well and thriving, while the large majority of the economy is very sluggish or flat.  Medical device makers are doing well but health services consumption and pharmaceuticals (both western and Chinese) are mediocre at best.  As I noted yesterday, mass travel specifically via highway is flat but international air travel comprising a small portion of total passenger trips is up robustly.  There are numerous other examples where the largest market is quite sluggish or declining but some small sector or company within the larger whole is flourishing.  I think there are three important take away from this burgeoning idea.  First, the largest markets simply are not growing remotely close to 7% even though significantly smaller subsectors or companies are.  We should not mistake the total growth for individual growth.  Second, growth opportunities for companies or sectors absolutely do exist.  Growth in China is not dead, though not anywhere near the fantasy 7%, but will require much more focus.  Third, growth is coming for higher end products and services not mass market consumers.  International air travel comprising 0.2% of all passenger trips is up nearly 40% YTD YOY, while road travel comprising nearly 85% of passenger trips is down 0.5%.  Those segments are serving two very different populations.

Is Chinese Travel and Tourism Up Strongly? Absolutely Not

The latest sector that perma-pandas are clinging to as proof of a 7% GDP growth economy is travel and tourism.  Fresh upon the heels of official data showing Golden Week outbound foreign travel was up 36.6% from last year and reports of Chinese tourists “buying up everything”, perma-pandas took this as evidence that the Chinese economy was strong signaling strength in services and consumption.  Slowing entry numbers into Hong Kong and Macau however, was evidence of the anti-corruption crack down and that Chinese are turned off by Hong Kong ideas of democracy.

The problem with this simplistic analysis is that it relies on incredibly narrow data points to read into an economy of 1.3 billion people.  In statistics parlance, these are all incredibly biased samples for different reasons on very narrow sub-groups.  As I have noted before, China is not nearly data poor as is widely believed though not as data rich as other places.  However, we have much better and wider data on the state of Chinese tourism than such simplistic narrow measures.

Let’s begin by trying to provide some context around some of the more attention grabbing travel headlines.  First, air travel only accounts for about 2% of all passenger travel in China.  Consequently, extrapolating from such a narrow sample to project upon the all of the travel industry or even Chinese economy is problematic.    Given a recent statistical change in data compilation, which I will explore later, it is quite possible that air travel accounts for an even significantly lower percentage than 2%.  As a point of comparison, waterway travel in China accounts for about 1.4% of travel.  It seems incongruous to focus so heavily on air travel and omit virtually any mention of waterway travel.

Second, not only is air travel a tiny portion of the over travel sector, international air travel is a tiny part of an even tinier part.  International air travel comprises only about 10% of all air travel in China.  In other words, international air travel is equal to 10% of a 2% percent market or roughly 0.2% of the entire Chinese passenger travel market.  It seems rather problematic to project onto the entire Chinese economy based upon the consumption behavior of the truly 0.2%.

Third, according to broad passenger data, air and railway travel are up a healthy 12.3% and 7.1% respectively year to date.  Even waterway passenger travel is up a more moderate 3.3%, which remember is only a little smaller than air travel by passenger number.  However, while these are healthy growth numbers, these segments of passenger travel only make up 16.7% in all of China.  Highway passenger traffic which comprises 83.3% of all passenger travel in China is down 0.6% year to date.  Consequently, all passenger traffic in China is up only 0.5% year to date.  In other words, these giddy proclamations citing international travel data relying on the top 0.2% of the population are missing the story of what is happening to Chinese travel.

Before proceeding, I want to note a specific issue about passenger travel data.  There is a data break in official highway passenger travel between calendar year 2013 and 2014.  Consequently, we can only compare backwards one year.  In the data break, highway passenger traffic was reduced by about 50%.  I have been unable to find any official document that addresses why this change took place.  I have been told it has to do with redefinition of highway traffic based upon the type and size of the road, though as noted I have been unable to confirm this officially.  While this prevents us from comparing data before 2014, we can compare for the last year and incorporate other data sources to provide a fuller picture.

Given the 2013 to 2014 data break and other reasons, I can understand skepticism about how accurate or reliable highway passenger data is informing us about the state of the Chinese travel industry.  At this point, let’s begin to incorporate other data to provide a fuller picture.  One area to look at is listed company revenue.  However, it is very important to provide some context.  First, the companies are not representative of passenger volume.  For instance, air transport revenue is approximately four times the size of road revenue.  Second, these industries do not provide break down by freight and passenger revenue so it is again not entirely representative for our purposes.  Third, while we should not entirely accept it, we can use it understanding its limitations.

Air, water, highway, and rail transport operating revenue registered 4.1%, -8.4%, 8.1%, and 8.0% growth in H1 2015 from H1 2014.  It is worth noting that the road and rail the two largest segment registered solid growth though due to which companies are listed, their total revenue was only 21% of these specific transport industries.  However, totaling across these specific transport sectors, operating revenue increased only 0.8%.  While the limitations need to be recognized, this again fails to paint a picture of robust growth.

There are other ways to study the travel sector and that is hotel and restaurant data.  If passengers are travelling, they will need places to stay and things to eat.  If the highway passenger data is inaccurate in someway, we would expect this to show up in hotel and restaurant data.

Unfortunately, hotel and restaurant data is even worse than travel data.  Beginning with listed firms, YTD YOY hotel and restaurant operating revenue is down 0.3% and 16.0% respectively.  Operating profit for each is down 4.4% and 138.6% respectively.

However, it is possible that like listed transport financials, this presents an incomplete picture.  However, broader data largely supports this picture of hotels and restaurants.  Per room revenue across all provinces increased only 1.0% through 1H 2015, total operating revenue for hotels across all provinces declined 0.4% through the same time period, and room rates increased only 0.2%.  If we look broadly at the restaurant sector, there is a further lack of evidence of strong travel and tourism.  According to UnionPay Advisors, restaurant spending has dropped 12%.  This is very much in line with the financials of the listed firms.

If travelling and tourism is booming, it certainly is not showing up in broad measures of passenger, hotel, or restaurant data.  I include hotel and restaurant data because if people are going to travel, they have to have places to stay and eat.  It is totally inconsistent to believe that broader passenger volume is up strongly while hotel and restaurants are flat or down.  In short, there is no evidence of strong growth anywhere in the hotel or restaurant sector if people are travelling.

There two final final but important aspects to note about all of this data and how to interpret it.  First, it is not contradictory to believe the largest number of Chinese are not growing but that a small number continues to enjoy significant success and enjoy luxuries like international leisure travel.  As has been noted in many places around the world during recessions or slowdowns, the wealthy or high skilled labor are not impacted nearly as badly as middle and lower class households.   This would explain why broad passenger traffic is flat, domestic air travel is up 10.3%, and international air travel is 38.1%.  These are different populations with different experiences through the slowdown.  It appears that the slowdown is hitting the broad population reducing consumption of goods and services but as with other countries, many at the upper end of the income and wealth level are prospering.

Second, even air travel however is having to change its strategies to continue to boost numbers.  While air passenger travel is up 12.3% YTD YOY, listed air transport operating revenue is only up 4.1%.  If we focus on a specific airline, we see evidence of the relative decline in pricing power.  Air China saw revenue per passenger kilometer decline 5.7% total  and domestically by 6.7% (PDF). China Eastern saw even larger declines at 7.9% and 8.9% respectively (PDF).  In other words, to induce additional passenger growth it cut prices by a relatively significant amount.  This is simply not indicative of a robust travel market and strong passenger demand.

Just as the Beijing or Shenzhen home price is not representative of China, neither is focusing on air travel and specifically the international variety.  The weight of evidence clearly demonstrates broad weakness in the travel, passenger transport, hotel, and restaurant sectors.  Neither revenue nor output support the perma-panda belief in 7% growth.

A Few Follow Up Thoughts to Rebalancing the Chinese Economy

A wanted to post a few follow up thoughts to my FT Alphaville piece on the difficulty of rebalancing the Chinese economy.

  1. As was noted, this is an ongoing piece of work trying to better understand what is going on in the Chinese economy. I’ve already gotten a couple questions about things to consider and let me assure you, I will try and present more data.  If the facts and data change, then my opinion will change.
  2. From the Goldman Sachs report on New and Old China I highlighted, they recognize the same problem I note about the difficulty rebalancing given the relative difference in size writing “…the absolute size of ‘New’ China is still small”: it accounts for 21% of total China market cap and only 8% of 1H15 profits. We highlight a list of fast growing and GS Buy-rated ‘New’ China names in Exhibit 40.” As I have said, there are companies or sectors that are growing rapidly, however, they are relatively small sub-sectors and not enough to rebalance the Chinese economy or drive 7% GDP growth.
  3. One of the most telling indicators to me of corporate health anywhere is tax revenue growth. The tax man is going to get their share.  According to my data, corporate tax payments declined 4% H1 2015 from H1 2014.  Given the widely noted difference around the world between what companies report to investors and what they report to the tax man, tax payments are in many ways a better gauge.
  4. Another concerning aspect is the rise in accounts payable. In the past two years, as operating revenue has been just above flat at an annualized growth rate of 1.4%, accounts payable have been increased at 12.6% per year.  That indicates to me that companies are slow walking their checks to their suppliers.
  5. I am really struggling to see how 7% GDP growth is the highest probability outcome here.
  6. GDP growth is largely irrelevant if the cash flows fail to support the ongoing operations of economic activity and specifically debt repayment.
  7. There is increasing debt stress on Chinese firms. Negative operating revenue growth and rapidly expanding  debt levels do not portend positive things.
  8. Rebalancing the Chinese economy is going to be very difficult without significant stress at some point.
  9. Do read the FT Alphaville piece on projected RMB outflows.  The RMB and credit are the two major stresses to watch in my book.

Simple Thoughts For a Holiday Thursday

  1. On the anniversary of the creation of the People’s Republic of China, I would like to wish China and all of my dear friends here a wonderful day of celebration.
  2. Though I have significant concerns about future economic and financial risks of China, I have thoroughly enjoyed the six plus years I have already spent living and working here and look forward to more
  3. I am blessed to work with some very good colleagues and teach very bright students at the best university in China (No Tsinghau, we are still the best.).
  4. It is inconsistent belief that the Chinese government would control information and manipulate data in areas from the environment, human rights, and even acknowledged economic areas like unemployment but then behave as angelic choir boys in the production of GDP/economic data.
  5. It is inconsistent to believe that a government that employs 2 million people monitoring the internet, tracking, and limiting speech is at the same time incapable of or too poorly trained to assemble economic data.
  6. I find it curious that people who so ardently defend Chinese economic data do not actually present official Chinese economic data, rather taking it as a given, to make their case.
  7. I find it curious that people who so ardently defend Chinese economic data begin by saying “there are significant problems” with Chinese data and close with “but we should believe it anyway.”
  8. China has a lot more data that allows us to make comparisons than most people realize. However, it takes ingenuity and tenacity to dig in the data trenches.
  9. If economists are scientists, we should continually seek to verify the data and mechanisms to test if they match the observed empirical reality.
  10. Accepting numbers because they are handed down from authority figures and using that reasoning as a defense transforms the analyst into theologian rather than data scientist.
  11. I hate to say it but I like Thai and Indian food more than Chinese food.
  12. I strongly believe the next few years will be very, very interesting.
  13. Even in my six plus years, China has changed enormously. The physical standards and comfort of living here continue to increase rapidly in Shenzhen.  The severe and increasing restrictions on information, crackdown on academics, lawyers, and journalists is obvious and felt throughout by many.
  14. Hong Kong is a frog in a pot.
  15. I am amazed at how fast children can learn a language.
  16. The goal of increasing innovation is inconsistent with the restrictions on information, thought, and freedom of speech.
  17. China is facing a point in history where inherent contradictions will seek a more permanent resolution.