PIMCO's forecasts call for 5.5 to 6.5% growth in Chinese gross domestic product (GDP) in 2016. This figure is above the global average but substantially lower than China's performance over the preceding decade. China's real estate and capital markets experienced deceleration and volatility between 2014 and 2016, with concerns about insufficient demand and fiscal overstimulation causing investor discomfort. PIMCO's modest view for China's GDP growth in 2016 is limited to the upside by concerns over the real estate market, rising sovereign debt, growing nonperforming loans, equity volatility and policy overextension.
Real Estate Market
The Chinese real estate industry has been an important factor in the country's economic growth, rising above 15% of GDP in 2014, fueled by high domestic investment. Strong real estate performance stimulates other industries such as construction and basic materials, so the knock-on effects of rising demand for housing and commercial space are substantial. The Chinese real estate market has been heavily supported by a government that has ensured low interest rates and accommodative lending standards. Unoccupied ghost cities in various parts of the country have been well documented, and concerns about excess capacity have threatened the outlook for the real estate market and the entire economy.
Property prices fell in 2015 but rebounded in early 2016 in China's top-tier cities. The slide continued in smaller cities. Some analysts have suggested real estate investments are being funded by capital flowing out of China's equity markets, though occupancy data suggests much of the strength in surging geographies is not being driven by speculation. In PIMCO's view, sluggish performance in smaller cities and inventory overhang are sufficient to limit real estate's potential to modest positive growth. This creates a drag on GDP growth relative to historical performance, because real estate is such an important part of the Chinese economy.
China added $21 trillion in debt between 2007 and 2015. While the sovereign-debt-to-GDP ratio climbed from 32% in 2006 to 43.9% in 2015, GDP growth fell from 15.4% to 6.7%. Government spending has become an important element of GDP growth as the Chinese economy experiences cyclical slowdown, so the country would have to take on roughly 15% more sovereign debt to achieve its GDP targets at the current rate. Leverage is not high enough to represent a serious threat to economic well-being, but the expanding role of government and diminishing marginal returns limit upside potential.
Nonperforming loans (NPL) in Chinese banks more than doubled in 2015, bringing the reported NPL ratio to 1.4%. PIMCO expects this figure to increase over the medium term, and stress tests suggest this figure could climb as high as 6%. If these downside scenarios are realized, it could require recapitalization of Chinese banks. NPLs are long-term problems and do not represent an imminent threat in the current cycle, but could influence policy in the short term. This lingering threat can also inhibit investment, which is important for sustained growth.
Chinese equities were highly volatile in 2015 and 2016, and corrective policy often lacked efficacy in response. Stock market volatility can be harmful in the real economy when it impacts investor confidence or consumer sentiment. Uncertain investors can withdraw their assets from an economy, resulting in capital flight, which limits growth potential. Poor consumer sentiment reduces aggregate demand and can be a drag on economic growth. Poorly conceived policy designed to address equity volatility can also impact currency and stifle business investment.
Monetary and fiscal policy have already both been heavily used by China to address economic and capital market inadequacies, and the marginal effects of additional actions are diminished. Sweeping currency depreciation measures led to capital outflow and pushed interest rates closer to theoretical efficacy thresholds. Fiscal stimulation contributed to excess capacity in some manufacturing or real estate categories, and there are fears that true demand from businesses and consumers cannot be simulated indefinitely.