China is going back in time

(REUTERS/Tyrone Siu) 

Workers carry an advertisement promoting the Chinese edition of "Deng Xiaoping and the Transformation of China." 

China is about to go back nearly 40 years in time, one of the most in-demand analysts on the country says.

Charlene Chu at Autonomous Research published a prediction this week that secondary-industry output — think production and construction — could contract in 2016.

That would be the first reduction on record since 1978.

To recap, China reformed its economic system in 1978 under Deng Xiaoping through the gaige-kaifang policy. The weakening of Soviet-style central industrial planning led to China's economic miracle.

Chu said that she has spent more time discussing this issue, and the chart below, than any other in the past few months.

"The reason is simple: despite a host of encouraging policy pronouncements and hype over brief improvements in macro data, nearly half of China’s economy was growing at just 1.2% yoy in 3Q15. And that is according to unadjusted, official data," she said in the note.

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(Autonomous Research) 

That is likely to drag overall gross domestic product down, as positive signs in services and consumption will not be sufficient to offset the lost growth in secondary output. It also has implications for the banking sector.

"The implications for the financial sector are bleak, with a disproportionately large 63% of outstanding loans estimated to reside with borrowers in secondary industry. For these reasons, we expect no turnaround in GDP growth or the credit cycle in 2016 and arguably 2017 as well."