China, the 'least sick patient on the ward', is still looking peaky

China's GDP growth fell to its lowest since 1992. But the country's $585bn stimulus package is beginning to bear fruit.

Investors across the world have been pinning their hopes on the notion that the downturn may be ending. In most markets this is wishful thinking but in China the latest data really do appear to point to "bamboo shoots of recovery", as The Economist puts it. China's $585bn stimulus package is bearing fruit.

GDP growth fell to 6.1% year-on-year in the first quarter, the lowest such figure since 1992. But compared with the fourth quarter, there has been a strong improvement. China's statisticians don't calculate growth in this way, but JPMorgan reckons that GDP increased by an annualised 6% between January and March after almost stalling in the autumn; according to Citigroup, the annualised increase in the first quarter was around 5%, after less than 1% in the fourth quarter.

Industrial production, one of the more reliable indicators of overall growth, increased by an annual 8.3% in March, double the pace in the first two months of 2009. Fixed asset investment, a key driver of growth, is looking healthy, registering a 30% annual rise in March, the strongest figure since October 2007. Retail sales growth, helped by discounts and tax breaks, also rebounded from February, gaining 14.7% year-on-year in March. Economists have nudged up their forecasts for 2009; RBS, for instance, is now pencilling in growth of 7%, up from 5%, while the central bank insists it is on track for its 8% target.

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The figures suggest that the pace of growth may have bottomed out, but that doesn't mean it's going to shoot up to 2006/2007 levels from here. Progress so far has been underpinned by exploding bank loan growth since the government lifted lending quotas a few months ago; loans are growing at an unsustainable 30% year-on-year, the fastest clip in over a decade. New loans in the first quarter totalled RMB4.6trn, about as much as 2008's overall figure.

Loan growth is now likely to be curbed given that officials are already worried about increasing non-performing loans and creating asset bubbles according to Credit Suisse, up to 40% of the new money lent by banks could be seeping into stocks and property.

Demand growth fuelled by loans has hitherto been concentrated in the state-owned industrial sector, says Capital Economics. Once it slows, the private sector may not increase investment much, given that it typically relies on profits rather than bank lending, and earnings are on the slide.

Meanwhile, exports are still in decline down an annual 17% in March as global demand remains lacklustre. At the same time, long-term sustainable consumption growth won't emerge until reforms to improve health care and construct a social safety net reduce households' incentive to hoard money. All in all, China is still "just the least sick patient on the ward", says John Foley on Breakingviews.

Chinese stocks, however, have zoomed ahead of the fundamentals, says Morgan Stanley. The MSCI China index up 66% since October looks pricey on a 2009 p/e of 13, especially with its earnings likely to fall by 15% rather than expand by 2% as the consensus expects. Morgan Stanley thinks the index will finish the year around 18% below its current level.