The book that most influenced my thinking about how to approach the Chinese economy is Capitalism with Chinese Characteristics by Yasheng Huang of MIT. More than the factual information, which is great by itself, he imparted a simple lesson: more than probably any other economy, details matter when studying the Chinese economy.
Prof. Huang uses two simple examples from his book to illustrate his point. First, though economists with Chinese encouragement classify private companies based upon their legal classification, this overlooks the importance of government shareholdings. As Chinese banks can attest to today, just being a listed company does not make you a private enterprise. According to his calculations, if we account for these types of distinctions, as much as 80% of the Chinese economy is still managed by the state. Second, many “Chinese” companies that most people have heard of such as Lenovo and Alibaba are not actually Chinese companies. They are registered elsewhere for good reason.
There are many other examples in the book and many others I could provide about the importance of paying attention to the details of the Chinese economy. I by no means claim to have mastered this art but I am continually asking how can we dig beneath the surface of a flashy number or statistic to make sure I am understanding and taking prudent precaution to verify a specific issue. The problem is so frequently, when you dig beneath the surface of Chinese data, you uncover a bunch of dead bodies.
Yesterday, the National Bureau of Statistics China announced that retail sales China clocked in at a solid 10.8% growth. There are however significant reasons to doubt this number. As I have already written elsewhere, output of consumer products in China is flat or falling. However, just because China isn’t producing consumer products doesn’t rule out the possibility that retail sales are going up.
To examine this closer, I downloaded data from the report covering the 50 and 100 largest retail enterprises in China with sales broken out by category. Looking at the 50 largest retail enterprises in a year over year basis, except for jewelry, all other categories are negative. Looking at the 100 largest, jewelry is still the largest gainer at 8.7% with food registering a 4.9% gain. Total retail sales among the largest 100 registered a total gain of 1.5% year over year. Most interestingly about the top 100 year over year retail sales, there is not one category that reaches the 10.8% claimed by the NBSC.
If we look at the year to date YOY sales of the top 50 retail enterprises, total retail sales grows by 0.9%. In fact, only one category grows by more than 3%, jewelry which grew at only 4.2%. The short version is that looking at the major retailers of China, there is no evidence to support the official statistics that consumer retail spending is a robust 10.8%. While it is possible that major retailers are registering flat and declining numbers depending on specific category, while China nationally sees such robust growth of 11% is highly unlikely. Furthermore, the retail sales of major retailers matches closely what we know about the flat output of consumer products in China. It is very difficult to reconcile falling consumer output and flat major retailer sales with the official story of 11% growth.
There is however an even more important point that needs to be made. Headline official data of 7% GDP growth and 11% retail sales growth are in most ways irrelevant to a firm. Businesses rely on cash flow to pay for workers, machines, and space. If we look at retail related cash flow for 2014, as it is not yet available for 2015, there is an enormous discrepancy between the official data of 12% retail sales growth and the cash flow associated with retail businesses.
Looking at the “Comprehensive Retail” financials, sales growth for 2014 was only 3.8% with profit growth of 4.4%. Food saw the largest sales growth at 5.7% in a year when China was touting national retail sales growth of 12%. Even if we assume that GDP growth is actually 7% and that retail sales are proving robust at 11-12%, firms are not enjoying the cash flow benefits. A high point of sectoral cash flow of 5.7% is no indicative of firms enjoying robust growth. The slow cash flow growth would indicate that the retail slowdown has been going on much longer than initially believed.
There are a few points of economic analysis worth mentioning. First, we pay close attention to GDP and retail sales because we expect them to be good proxies of economic health and activity. However, firms pay with money not official GDP figures. Consequently, even if we stretch credibility and accept official GDP and retail sales numbers as perfectly accurate, firms are not seeing the related cash flow. Second, it appears that the retail slowdown has been much more prolonged than people realize. I present data here that covers revenue growth for the retail industry for all of 2014 showing sales growth of 3.8%. Again, if we believe the official retail sales growth number of 12%, firms live on cash flows and the slow down appears to have begun no later than 2014. Third, this data directly contradicts the entire economic rebalancing story in China. According to the data consumption is simply not outpacing growth in the traditional drivers of Chinese growth such as fixed asset investment. Fourth, this data comes much closer to matching most other data points we have such as consumer output, electricity, freight, and related data. If we ignore the topline official data, none of the underlying and independent data supports a 7% growth story.
Despite what people may choose to believe or disregard, it is incredibly difficult to reconcile official national statistics with more granular industry data on retail sales. Furthermore, when we also consider the consumer product output data coupled with large retailer sales data, it is difficult to accept official data. The most worrying part is that even if official GDP and retail sales data is accurate, the cash flow required to support the debt and return numbers indicate significant stress at the firm level.
The more we pay attention to the details of the Chinese economy, the more difficult it becomes to reconcile with official data and the more worrying the picture becomes.
Note: You canfind all the data herecited in this blog. I apologize you need to download the data, I am having trouble inserting figures into the blog.