There are few things that can divide financial markets more than Chinese economic data, particularly when it comes to the nation’s quarterly GDP figure.
Whether because it has a curious knack of always coming in around market forecasts, or due to the fact it is produced just two weeks after the conclusion of the quarter, many in financial markets simply don’t believe its accuracy.
It’s fudged, a furphy and unreliable, the China sceptics say, suggesting that the figure is simply derived by Beijing to serve political, face-saving purposes.
Start with what the government wants the figure to be and simply work backwards is the way many analysts view the statisticians’ role in constructing the GDP report.
That sentiment has only been bolstered by the revelation that current Chinese premier Li Keqiang, as then party committee secretary of China’s Liaoning province in 2007, suggested that the province’s GDP figures were unreliable, choosing instead to look at loan growth, railway cargo volumes and electricity production.
That admission even led to the construction of an economic model bearing his name — the Li Keqiang Index (LKI) — that was created to gauge what was happening in the broader Chinese economy.
Given this alternative growth proxy has been sitting well under the official growth figures for many years now, China data sceptics still point to LKI to bolster the case that the Chinese GDP figures are fake.
However, what if the Chinese GDP figure isn’t as fanciful as it appears? What if the Chinese economy really is growing at a year-on-year rate of 6.7% as reported in the March quarter of this year?
In order to answer that question, Wei Li, a member of the Commonwealth Bank’s China economic team, has decided to create a new model to track Chinese economic growth.
Known as the bank’s China GDP Tracker (CGT), it uses four individual indicators to provide a monthly indicator of official GDP growth: the growth of value-added of industry (VAI), growth of retail sales in real terms (SAL), average growth of Shanghai Stock Exchange composite index (SSE) and growth of housing sales measured by floor space (HOU).
Here’s the calculation used to derive the CGT level:
CGT = 0.025 + 0.45*VAI + 0.09*SAL + 0.01*SSE + 0.003*HOU
Compared to other alternate China growth indicators such as the LKI, he suggests that this model provides a more comprehensive measure of Chinese economic growth, particularly as it includes inputs from the nation’s services sector, now the largest component of the economy.
“The CGT provides a more comprehensive measure of the overall GDP performance, based on four variables covering 72% of China’s GDP,” says Li.
“By contrast, the Likeqiang (LKQ) index, which is calculated based on electricity production, railway freight traffic and real loan growth, is heavily skewed towards industrial sectors.
“The inclusion of both electricity production and railway freight traffic at the same time also means one of them would not be able to pass a statistical significance test to be included in a forecast model.
“We dislike loan data because it performs poorly in economic studies.”
After applying prior data into the model, this is how the CGT compares to the official growth figures released by the government over the past 10 years.
It certainly has a closer relationship to the official GDP figure than other alternate growth indicators, such as the LKI, at present.
According to Li, the model suggests that “current GDP growth is likely to be close to 6.0% yoy, rather than 6.7% yoy as the official figure suggests”.
Although still below the official figure, the modelling suggests that the economy isn’t growing at a sub-5% level as some other indicators would have you believe.
Li suggests that based off the data received between April and May, China’s Q2 GDP growth should come in at 6.6% year-on-year, slightly below 6.7% pace recorded in the first quarter of 2016.
While some will dismiss the model, pointing out that it simply uses other official Chinese data along with movements in Chinese stocks, something that has had a chequered track record in recent years, it does have a reasonable relationship to the official GDP figures as seen in the chart above.
It also provides a welcome reminder that China’s economy is changing, with services replacing secondary industries as the largest component within the economy.
As it changes, so too must the focus of models, and of financial markets.
Chinese Q2 GDP is scheduled for release on July 15.