Here's what everyone missed in China's 7.7% GDP results

Growth may have been better if adjusted for the leap year effect.

According to UBS Investment Research, while China’s economic recovery has been weak, the 7.7% y/y GDP growth figure for Q1 2013 nevertheless surprised almost everyone in the market.

UBS noted that Q1 GDP growth may have been closer to 8% if adjusted for the leap year effect. This means that the underlying momentum may have weakened from Q4 2012, but not by as much as suggested by the headline number.

Here's more:

There are certainly a number of reasons for the weakness, including the government’s frugality campaign that slowed food-related consumption, a sharp decline in property starts in March, and continued destocking in some sectors.

We wrote on April 15 that the leap year effect – Q1 2013 had 1 fewer day than Q1 2012 - may have not been taken into account and the headline growth rate may understate true momentum in the economy.

We now have formal confirmation from the National Bureau of Statistics (NBS) that indeed leap year effect has not been adjusted. We are told that the common practice is not to adjust for leap year, but the NBS sometimes would explain to the public that such a factor has had an impact on the headline
numbers. 

In developed economies, the conventional practice is to adjust for leap year effect while calculating the seasonally adjusted q/q growth rate, since that is what everyone focuses on, while some countries also “working day-adjust” for the y/y growth rate.

What does this finding leave us?
We believe the unadjusted Q1 2013 GDP growth understate the true strength in the economy, though not clear by how much. Simply adjusting for one more day will give us an estimate, but the underlying assumption that every day is the same in production and consumption would be false.

We do not have sufficiently long quarterly data in China to do better adjustment for leap year. 

Apart from GDP, activity data reported for Jan-Feb may also under-estimated the underlying momentum, including power consumption, industrial production and retail sales. 

Nevertheless, activity in Q1 2013 was relatively weak. Industrial production slowed markedly in March, power consumption slowed sharply, and retail sales remained weak as well.

These can not be explained by leap year effect. More importantly, property starts and completion fell sharply, obviously affected by the announcement of new property tightening measures. 

In the end, we think Q1 GDP growth may have been closer to 8% if adjusted for the leap year effect. This means that the underlying momentum may have weakened from Q4 2012, but not by as much as suggested by the headline number. 

This is consistent with our view that recovery should resume from Q2 onwards. We maintain our 8% GDP growth forecast for 2013.