This was the year that the Chinese economy was meant to roar back to life. Its reopening, after draconian Covid-19 restrictions, was touted by financial markets as 2023’s biggest economic story. In some sense it still is — but for different reasons.
The world’s second-largest economy grew just 0.8 per cent in the second quarter, compared with 2.2 per cent in the first three months. A slew of data, from industrial activity to business investment, also paints a downbeat picture for the months ahead. Investors are trying to work out if China’s recovery may have already ended.
There are three core drivers behind the sluggishness. First, China’s export-reliant economy is suffering from weak demand for its goods as high interest rates crush advanced economies. Demand has also shifted away from goods like consumer electronics and Pelotons, which propped up its output during the pandemic; in the west, consumers are spending more on restaurants and holidays instead. This has strained China’s economy, which accounts for almost a third of the world’s manufacturing output.
Second, consumer confidence within China is weak. Although savings built up during the pandemic, retail sales have since disappointed. A drop in China’s housing values has made homeowners feel poorer, while prospective buyers are holding off. New home prices are poised for the longest period of falls since records began in 2011. Unemployment among China’s graduates is also weighing down enthusiasm in the economy — youth unemployment has surpassed 20 per cent.
Lastly, business investment is depressed. President Xi Jinping’s regulatory crackdown on tech firms in recent years and broader geopolitical tensions with the US have exacerbated uncertainty. Private fixed-asset investment shrank 0.2 per cent in the first six months of the year, compared with the 8.1 per cent growth in investment by state entities. Real estate investment, which has driven China’s economy for about two decades, has slumped too.
Despite the gloom, most analysts expect the economy to grow above 5 per cent this year, which means China will still drive the global economy as the US and eurozone economies slow. Investors are hoping that the Communist party will nonetheless act to stimulate the economy.
There is, though, little fiscal space. Local government debt amounts to about $9tn, or almost half of total gross domestic product. As the country flirts with deflation amid weak domestic demand, the real costs of servicing huge debt repayments could rise. China’s headline annual inflation rate in June was 0 per cent.
Government policy is largely to blame for the slowdown. Decades of relying on an investment-driven growth model has slowed China’s transition to a consumer-based economy. Poor oversight of the housing market led to an unsustainable lending boom, while political impediments have hamstrung private enterprises. Heavy-handed Covid restrictions have also left deep scars.
To avoid a debilitating deflationary cycle from becoming embedded, the government will need to act fast. For starters, entrepreneurs and established businesses need stability and regulatory clarity from the government. Further monetary policy loosening by China’s central bank could help. Beijing will also need to restructure its local government debt; one option might be a fire sale of state assets to private companies. The proceeds would help local authorities to avoid a debt crisis.
There is hope that China’s ruling politburo will outline further support measures at a meeting this month. It got the economy into this fix, now it needs to find a way out.
Source: Economy - ft.com
