1. China’s Economy: Slowing,
Distorted and Debt-Addicted
Marcus Wright
Senior Economist, RBS, February 2016

2. China – the problems behind the headlines
China’s economy is:
• Slowing – GDP growth has slowed more than the headline
figures suggest, investment and production in particular
• Distorted – overly reliant on investment with little sign of
rebalancing
• Debt-addicted – a post-crisis debt build-up that is proving hard
to shake off
• Coupled with ad-hoc and uncoordinated policy we believe
China is more likely in a hard landing than a ‘bumpy landing’.

3. GDP growth – always on the money
4
6
8
10
12
14
16
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
ChinaGDP Growth
v Target
GovernmentTarget GDPGrowth
Source: Bloomberg
0
5
10
15
20
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
China GDP
(% Y/Y Change)
GDP (Official)
GDP 'Proxy'
Source: Bloomberg, Macrobond
• China’s GDP growth figure
always comes in remarkably
close to target
• And it’s never revised
• By the admission of the
Prime Minister GDP data is
“unreliable”
• It’s difficult estimating
China’s ‘true’ growth rate
• But a figure of around 3-4%
seems reasonable.

4. But investment has slowed sharply
-10
0
10
20
30
40
50
60
2011 2012 2013 2014 2015
China - Investment by Sector
(y/ygrowth)Real Estate
Infrastructure
Manufacturing
Source: Bloomberg
• China’s post-crisis investment
boom is unwinding.
• Demand weakness at home
and abroad, as well as existing
excess capacity, has dented
manufacturing investment
growth.
• The property market is starting
to work through the inventory
overhang. But property
investment has stopped
growing.
-30
-20
-10
0
10
20
30
40
China Housing Market
(Construction and Sales, y/y change)
houses newly started
houses under construction
houses sold Source: Bloomberg

5. And so has industrial production
70
75
80
85
90
2
4
6
8
10
12
14
16
2011 2012 2013 2014 2015
China - Industrial Production
and Capacity
IndustrialProduction- y/y change - lhs
CapacityUtilisation- rhs
Source: Bloomberg
-20
-10
0
10
20
30
40
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - Cement, Steel & Electricity
Production(y/y change, 4mma)
Steel Cement Electricity
Source: Bloomberg
• All the years of excess
investment has left a legacy of
excess capacity.
• And the slowdown in
investment means China’s
heavy industries are having a
tough time of it.
• Electricity, cement and steel
production are all experiencing
y/y declines.

6. The disinflationary winds blow
-5
0
5
10
15
20
25
30
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - GDP and Deflator
(y/y % change)
Deflator
Real GDP
Nominal GDP
Source: Bloomberg
-8
-6
-4
-2
0
2
4
6
8
2010 2011 2012 2013 2014 2015
China - Inflation
(% y/y change)
Producer Prices
Consumer Prices
Core Consumer Prices
Source: Bloomberg
• And all that excess capacity is
weighing down on prices.
• Producer price deflation is
running at close to four years.
• And tellingly the GDP
‘deflator’(a wider gauge of prices
in the economy) has turned
negative.
• Domestic price falls and a
falling currency means
significant disinflationary winds
are blowing from China. Those
‘made in China’ goods are
getting cheaper.

7. Exports and exporting excess capacity
100
150
200
Dec/2013 Jun/2014 Dec/2014 Jun/2015 Dec/2015
China- Volume of Steel Exports
(Dec 2013 = 100)
Source: Bloomberg
• Chinese exports are struggling.
• And the volume of Emerging
Asia (predominantly China)
exports have been declining
since the spring of 2015.
•But China’s steel exports have
doubled in just two years.
• It’s a symptom of the build-up
of excess domestic capacity and
is driving global prices down.
-15%
-10%
-5%
0%
5%
10%
15%
20%
Jul/2013 Jan/2014 Jul/2014 Jan/2015 Jul/2015
China Exports
(Y/Y Change)
US
EU
Total($)
Exportsfrom EmergingAsia (Volume) Source: Macrobond, CPB

8. • China is on path trodden by
South Korea and Japan before
it where rapid economic
development is pursued
through a high investment to
GDP ratio.
• But China is an outlier
compared to the history of
those countries.
• And it’s an outlier when
compared to other emerging
markets, and has been so for
some time.
China’s investment level – out on a limb
15%
25%
35%
45%
1 11 21 31
Investment as Share of GDP
(%)
China(1996-2014)
Japan(1955-1985)
S.Korea (1976-2006)
Source: IMF
10
20
30
40
50
2000 2002 2004 2006 2008 2010 2012 2014
Investmentas Share of GDP
(%)
China
Indonesia
India
Malaysia
Mexico
Brazil
Hungary
Philippines
Poland
Russia
S.Africa
Turkey
Source: IMF

9. Rebalancing at a snail’s pace, if at all
30
35
40
45
50
55
1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
China - Consumption v Investment as
% of GDP
Household Consumption Investment
Source: Bloomberg
30
35
40
45
50
55
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - Manufacturing and Services
as share of GDP (%)
Services
Manufacturing
Source: Bloomberg
• Services as a share of GDP has
risen sharply in recent years.
• But that is attributed to the
build-up of financial services in
tandem with the stock market
rise.
• Economic rebalancing was in
desperate need on the eve of
the crisis. Instead, policy choices
distorted the economy further.
• The distortion is many years in
the making. Unwinding the
distortion will likely take years.

10. More signs of a lack of rebalancing
30
40
50
60
70
80
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Share of Total Labour Compensation
in GDP (%)
China US
S.Korea Indonesia
Japan
Source: Conference Board
• The volume of imports into
emerging Asia (predominantly
China) is contracting, a rare
phenomenon.
• Falling labour share of GDP is
a phenomenon seen across
many countries (owners of
capital taking an ever larger
share of the fruits of growth).
• But it was already low in
China and has only just begun
to turn.
-20%
-10%
0%
10%
20%
30%
40%
1994 1997 2000 2003 2006 2009 2012 2015
EmergingAsia Import Volume
Source: CPB World Trade Monitor
Asian crisis
Tech
bubble
burst
Global Fin.
Crisis

11. Loans are supposedly not in great demand…
3
4
5
6
7
50
60
70
80
90
2009 2010 2011 2012 2013 2014 2015
China - Lending Rate
v Loan Demand
Index of Loan Demand - lhs
Benchmark 1 year Lending Rate - rhs
Source: Bloomberg
• Loan demand had
supposedly dropped sharply in
China, despite the fall in
interest rates
• But although growth in the
stock of credit growth has
cooled it remains very strong.
0
10
20
30
40
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - Credit
Growth
(Outstanding,
Y/Y Change)
Source: Bloomberg
11.4%y/y

12. Just when you think they’re getting on top of all that credit…
0
500
1,000
1,500
2,000
2,500
3,000
China - Aggregate Financing
(RMBBillions)
Source: Bloomberg
-100%
0%
100%
200%
300%
-20%
0%
20%
40%
60%
Jan/2014 Jul/2014 Jan/2015 Jul/2015
China - Loan and Corporate Bond
Growth (Y/YChange)
Loans -lhs CorporateBonds -rhs
Source: Bloomberg
•China has had periods of
cooler credit growth. The
problem is they are not
sustained. The debt addiction
is proving hard to shake.
• December 2015 saw strong
credit growth with bond
financing picking up.
• The concern is that current
borrowing is good money after
bad, with a lot going to finance
existing debts.

13. How can this debt build-up be pain free?
15
18
21
24
27
30
33
100
120
140
160
180
200
220
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
China - Debt to GDP
and Debt Servicing (%)
Debtto GDP - lhs
DebyServicingCostsas % of GDP- rhs Source: BIS, Bloomberg
• $6.5bn per day – the rise in
China’s non-financial private
sector debt since the crisis.
• As we have previously stated,
a similar pace of debt increase
in other countries has led to a
financial crisis.
• The burden of China’s debt
build-up debt has led to a sharp
rise in debt servicing costs.
• The rise in corporate sector
debt in China and Hong Kong is
staggering.
-40
-20
0
20
40
60
80
100
Corporate Sector Debt
(% of GDP Change since Crisis)
Source: BISNon-financial Corp Sector

14. Forget equities, look at policy
• 2016 has been marked by falls in China’s currency and equities.
• The equity sell-off tells us little about China’s wider economy.
But the policy response does.
• In recent months economic policy in China has been reactive,
ad-hoc and seemingly uncoordinated between state institutions.
• And more fundamentally it shows there is a reluctance on the
part of the authorities to let the market have the final say in the
setting of prices in the economy.

15. The problems with pushing ahead with reforms
• Policy makers’ reluctance over market reform reflects two things
1. Conflict within the Chinese Communist Party (CCP)
about reform. Vested interest groups appear more
entrenched than previously thought.
2. Letting the market have the final say in the setting
of prices too readily conflicts with the CCP’s aims of
social stability and therefore the primacy of the Party.
• Authorities struggling with macroeconomic management and
crisis mitigation more than previously thought.
• This gives us less confidence the CCP can do/ will do the right
thing when it comes to reform and cleaning up the banking sector.

16. …and finally
• China’s debt binge – which has yet to begin unwinding –
remains too readily dismissed by the consensus.
• Our previous view of China experiencing a ‘bumpy’ landing is
changing. A ‘hard-landing’ is now the most likely scenario.
• China’s slowdown is already impacting the global economy
through the channels of growth, trade, inflation, interest rate
expectations and financial linkages. There is more to come on
all these fronts.
•We will elaborate more on this view and the impact it will
have on the UK and global economies in a future release.

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