Tracking China’s Service Sector

Sean Miner (PIIE)

November 7, 2016 4:15 PM

China’s service sector comes under frequent scrutiny in part because it is notoriously hard to track, with many indicators only coming quarterly or even annually, with significant lag times.[1]  As the driver of growth in China, having expanded more than the industrial sector, it is necessary to find alternative and more frequent data for the service sector.  The most visible frequent indicator of service sector growth, the official nonmanufacturing (services) purchasing managers index (PMI), reported a reading of 54 in October, its highest since 2014.

In 2015, the financial sector was a large driver of growth in services, as there was major activity related to China’s equity markets, but after the stock market crash that summer, the financial sector returned to its previous growth rate.  In the first half of this year, real estate was a big driver of China’s service sector; as sales took off, prices soared in many top tier cities, but this too may slow.  So where else can we look?

Alternative Indicators

There are a number of alternative measures, which as a whole show mixed growth.  China’s transition from industrial-driven growth to service-driven growth is exemplified in figure 1, which shows how domestic rail travel has increased, while industrial rail freight has slowed.

Figure 1 Passenger versus freight traffic on China’s railroads (year-over-year, 3-month moving average)

Source: Wind

However, some of that freight is now traveling by air or highway, supporting growth in the transportation sector, as shown in figure 2.

Figure 2 Freight volume (year-over-year, 3-month moving average)

Source: Wind.

While China’s domestic passenger rail has picked up and domestic air travel has risen steeply (3.5 million average domestic monthly air travelers in 2016, versus 2.5 million in 2012), the hotel industry has barely recovered from tough times in 2013 and early 2014 to see occupancy rates level out (figure 3).  This is likely because the number of hotels built has risen: Data for 2015 show that the number of hotel rooms and aggregate room revenue both grew.

Figure 3 China’s hotel industry (year-over-year, 3-month moving average)

Source: Wind

Two industries that hold promise for driving some of China’s service sector growth in the future are software and telecommunications.  Both have seen revenue slow down, although growth in the software industry is still extraordinary, maintaining monthly year-over-year growth rates of over 15 percent.  Revenue could also underestimate the growth of value added for each industry if prices have been falling, which they have in some areas. 

Figure 4 Software and telecommunications industry revenue growth (year-over-year)

Source: Wind

Banks are the largest part of China’s financial services sector. Interest income from 16 selected banks has gone into negative territory for the first time since 2009 (figure 5).  This is likely a symptom of China’s huge credit lending and a rise in nonperforming loans, or possibly the result of interest rate liberalization making interest margins thinner.

Figure 5 Bank interest income (year-over-year)

Note: This is a simple average of 16 banks’ interest income, including but not limited to: China Merchants Bank, Shanghai Pudong Development Bank, Industrial and Commercial Bank of China (ICBC), China Everbright Bank, China Construction Bank, Bank of China, and CITIC.
Source: Wind.

A good indicator of consumption of services like entertainment is spending at movie theaters.  China’s consumers are known for a high savings rate, and any indication of trouble ahead would likely see a cutback in spending on areas like movies or restaurants.  But according to China’s official statistics, box office revenue through October of this year was $5.9 billion, up from $5.6 billion for the same period in 2015. 

Prospects for the Future

While some parts of the service sector are humming along and others point to mediocre growth, there are many indications that the service sector will continue to be strong.  Disposable income growth of above 6 percent annually will continue to drive growth in tourism, entertainment, health care, and retail.  China’s information technology sector has seen a slew of startups in the past year that will likely continue to drive the software industry and telecommunications. 

Real estate is due for a slowdown, but as people begin to rebuild trust in China’s financial markets, and areas like peer-to-peer lending rocket ever higher, the financial sector will pick up some of the slack.  All this bodes well for employment, as the service sector is more labor intensive than the industrial sector.  So, as China’s labor force is set to continue to shrink, this can keep upward pressure on wages, fueling more spending on travel, entertainment, education, and health care. 

 

[1] The full disaggregated data for the service sector for 2014 was only released in late October 2016, a lag of nearly two years.

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