China’s Li Keqiang Index: Headwinds for Commodities?

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The official growth rate of China is of intense interest to economists and investors worldwide.  The gross domestic product of the world’s second largest economy is also subject to a certain degree of skepticism.  Observers ponder over its unusual stability and unfailing ability to fall within the consensus estimate.  Among the skeptics is none other than Li Keqiang, the Premier of the People’s Republic of China.  His remarks to a U.S. diplomat a decade ago describing the official GDP as “man-made,” inspired The Economist to create an index of his three preferred measures of economic growth in China that now bears his name: the Li Keqiang index. 

The index, which comprises the annual growth rate of outstanding bank loans (40%), electricity consumption (40%) and rail freight (20%), shows a significantly more volatile trajectory for China’s growth than the official GDP.  By the measure, China’s 2015 slowdown was much worse than the official GDP indicates, and the subsequent rebound much bigger.  That the index is volatile should not be surprising as it narrowly focuses on just three sectors, would show more variability than a broader measure such as GDP.

Just as there are skeptics of the official GDP, there are those who doubt the Li Keqiang index.  Several times in the past few years, the index has been pronounced dead.  However, to loosely paraphrase Mark Twain, rumors of the death of the Li Keqiang index have been premature.

While the debate over the ideal measure of China’s economic performance is an interesting and important topic, this paper aims for a more modest and testable goal.  It seeks to answer the question: which index, official GDP or Li Keqiang, is more relevant to investors?  The answer, as we demonstrate below, is resounding: the Li Keqiang index dominates China’s official GDP in its importance to commodity and currency investors.

Before we delve into which index has done a better job of forecasting movements in commodities and commodity currencies in the past, let’s begin with which index responds more quickly and accurately to China’s own domestic interest rate market.  As we have written in the past, China’s official GDP correlates highly with the slope of the 3Y-10Y bond yield curve (Figure 1).  This is even more true of the Li Keqiang index, which responds to changes in the yield curve slope even more quickly (Figure 2).

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