Signs Of Moderate Recovery‏ In China

China finally appears to have bottomed out and we expect it to recover moderately in the coming quarters supported by stronger domestic demand and some improvements in exports. The property market has continued its recovery and the tail-risk of a collapse has declined substantially.

Japan is in recession but we expect it to return to moderate growth in H1 13 supported by aggressive monetary and fiscal easing and a gradual recovery in exports. However, the Japanese economy will face severe headwinds in 2014 when the consumption tax is scheduled to be raised and the impact from reconstruction after the earthquake starts to wane.

In the short term, the biggest risk for China and Japan now appears to be the external development in Europe and the US. Longer term, the main risk for China is the pace of the long-term decline in China's growth potential.

Finally signs of moderate recovery in China
After a prolonged slowdown, signs have finally started to emerge in recent months that the Chinese economy has bottomed out and has started to recover. As no substantial output gap appears to have opened during the slowdown, the recovery is also likely to be moderate. An important question is whether the recent slowdown has been mainly cyclical or structural in the sense that it has been driven by a decline in China’s long-term growth potential. If the slowdown has been mainly structural, then there is little reason to expect a substantial recovery, and any attempt to counter the lower GDP growth with stimulus will prove futile and just end up boosting inflation.

Lower potential growth will be the biggest challenge facing China in the coming years. This has already been acknowledged by the new Chinese leadership with focus set to be on productivity boosting long-term structural economic reforms. With more focus on structural economic reforms, China might also have entered a new phase with greater tolerance for slower growth, particularly if there are longer-term efficiency costs with traditional macroeconomic stimulus. However, the sharp drop in inflation from 6.5% y/y in late summer 2011 to currently less than 2% y/y suggests that the slowdown has to a large degree been cyclical, albeit China’s potential GDP is in longterm decline (we estimate potential GDP growth to be in the 8.5-9.0% range).

Property market continues to stabilise
Sales of new homes have, in recent months, continued the recovery that started in May. Completions of new homes have dropped markedly as a lagged response to the sharp decline in housing starts late last year. Consequently, the demand-supply balance in the property market has improved substantially and our indicator for the market balance measured as the difference between new homes sales and completions of new homes is

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