Feature Stories | May 24 2023
There were great expectations of a rapid Chinese economic rebound, but as some analysts warn, it’s just not going to happen.
-Chinese data disappoint
-Working population shrinking
By Greg Peel
“Something is rotten in the Chinese economy, but don’t expect Wall Street analysts to tell you about it,” wrote Ruchir Sharma, Chair of Rockefeller International, last week. “There has never been a bigger disconnect, in my experience, between some of the rosier investment bank views on China and the dim reality on the ground”.
When Beijing suddenly, and unexpectedly, about-faced on its previously stubborn zero-covid policy early this year, analysts heralded a reopening rebound for the Chinese economy. And indeed, Chinese retail sales leapt 18.4% in April year-on-year, industrial production rose 5.6%, and fixed asset investment rose 4.7% year to date.
Which seem to corroborate reopening boom expectations, but in reality the opposite is true.
April data were anticipated to be significantly strong, as year-on-year the numbers were cycling China’s lockdowns of a year ago when the economy was all but shut. But economists had forecast 21.0% retail sales growth, 10.9% industrial production growth and 5.5% for fixed asset investment. The results, therefore, fell well short.
DBS’ senior economist Nathan Chow noted that on a month-on-month basis, China’s industrial production declined by -0.5% in April. Monthly automobile sales also declined as consumers adopted a cautious stance while automakers reduced prices.
While high-frequency data showed spending surged during the Golden Week holiday, it likely represents pent-up demand rather than sustainable consumption growth, Chow asserts. Consumers have probably already taken most "revenge travel" trips, evidenced by the cooling services purchasing managers’ index (PMI).
Modest 3.8% real income growth — below pre-covid’s 6.7% — indicates households lack the purchasing power for persistently higher spending. This is reflected in the benign core inflation of 0.6-0.7% over the past three months. Both Beijing’s and the independent Caixin manufacturing PMIs slipping below the expansion threshold in April illustrated the manufacturing sector is in no position to pick up the growth baton from consumption.
Plunging new loans in April pointed to deeper challenges, Chow warns. The slowdown in medium to long term corporate loans suggests private investment is unlikely to rebound swiftly. Declining mortgage lending despite supportive measures shows profound difficulties for the property sector. Externally, persisting strains in the banking sector and higher interest rates in the US and Europe are expected to pose lingering pressure on China’s exports.
Reopening set a good stage for China to grow the economy this year, notes Citi. In Citi’s 2023 outlook, analysts assumed confidence would improve along with data akin to usual cycles, generating a broad-based and organic recovery of the Chinese economy. This hope now seems misplaced, Citi admits, with confidence revival lagging significantly within the recovery.
With the initial reopening impulse set to fade, weak confidence could become entrenched and self-fulfilling. Citi warns this could be the number one downside risk to the Chinese economy now.
There seems to be a persistent lack of confidence among consumers, homebuyers, corporates and investors, Citi notes. Some common factors could be responsible, such as the scarring effect from economic downturns, zero-covid and its exit, and policy excesses in the past few years, and the sectors could still be re-anchoring long-term expectations. Weak expectations could be reinforcing each other and become entrenched and self-fulfilling.
With weak confidence the major threat now, decisive policy actions are much needed to break the vicious cycle. All the sectors could be waiting for the government to make the first move. After the wait-and-see, cyclical macro policy tools such as rate cuts and targeted fiscal easing are back on the table, in Citi’s view.
Hopes for a reopening boom were based on the premise that once released from lockdown, Chinese consumers would go on a spending spree, notes Ruchir Sharma, but company reports show no sign of one. If China’s economy were growing at 5% — which is Beijing’s target (while some optimistic analysts have higher forecasts) — then based on historical trends corporate revenues should be growing faster than 8%. Instead, revenues grew at 1.5% in the first quarter.
Corporate revenues are now growing at a slower rate than the officially stated GDP in 20 of China’s 28 sectors, including consumer favourites from autos to home appliances, Sharma points out. Weak revenues are in turn depressing earnings for consumer goods companies, which normally track GDP growth quite closely, but shrank in the first quarter.
Instead of a reopening rush, the MSCI China stock index has fallen -15% from the January peak and consumer discretionary stocks are down -25% since then.
If the optimistic analysts are right, and consumer demand is picking up in a “boomy” economy, imports would be strong, Sharma suggests. Imports fell -8% in April. And, as noted, April retail sales and industrial production data came in way below economists’ estimates.
China’s credit growth is weakening too, to half as fast a pace as forecasters expected. The debt service burden of Chinese consumers has doubled in the past decade to 30% of disposable income, Sharma notes, a level three times higher than in the US.
Many Chinese youth need a job before they can join a spending spree: urban youth unemployment is rising and last month topped 20%.
China’s economic model has been based on government stimulus and rising debt, much of it pouring into the property markets, which became the main driver of growth. But with debts already so high, the government was much more restrained in its stimulus spending during the pandemic.
By the start of this year, the Chinese had accumulated excess savings during the pandemic equal to 3% of GDP, compared to 10% in the US. While the US enjoyed a big reopening boost from stimulus, China did not this time.
Much of the stimulus over the past decade had flowed through local governments in China, which used their own “financing vehicles” to borrow and buy real estate, propping up the property markets. Those vehicles are fast running out of cash to finance their debts, which is curbing their investment in the property market and industry as well. Industrial sectors are slowing faster, Sharma notes, than the consumer-related businesses at the centre of the reopening story.
The Property Problem
China’s broader property sector has long represented an outsized share of its economy, National Australia Bank economists note, when compared with advanced economies. At various times over the past two decades, Chinese authorities have adjusted policies around the property sector – including guidance to banks on mortgage lending, altering the size of deposits for purchases and purchase restrictions in different locations – to either stimulate or cool the broader economy.
In addition, local governments have been highly dependent on land sales to generate revenue – particularly in lower income provinces – providing an incentive to keep the property sector flourishing.
Concerns over the excesses of property developers and their high debt levels led to the implementation of government policies in August 2020 that severely restricted credit to the sector, NAB notes, leading to the high-profile collapse of deeply indebted developer Evergrande, along with a range of smaller firms.
According to Bloomberg, China’s property developers defaulted on over 140 bonds in 2022, with missed payments totalling a record -US$63.7bn, compared with -US$9bn in 2021.
Zero-covid policies encouraged an increase in savings and negatively impacted consumer confidence, NAB notes. This was exacerbated by property developers’ long running tendencies to abandon construction projects when funding was exhausted – leaving them unfinished – which led to a “mortgage strike”. Purchasers of unfinished properties simply refused to pay their mortgages and as of late 2022, the issue remained unresolved.
The combined effect of these factors was a steep downturn in the property sector – with residential sales volumes falling rapidly along with new construction starts.
A range of headlines have touted the increase in sales values in the first four months of 2023 – up 11.8% year-on-year according to the government – but as NAB points out, this followed a -32% fall over the same period in 2022 – meaning growth remains well below earlier peaks.
Although property sales data appear to be stabilising at a considerably lower level than the previous peaks, new construction activity remains relatively weak. Property developers may prove cautious, NAB suggests, particularly given the collapses of several firms in recent years – waiting for a clear turn around in sales before committing to new projects.
From an Australian perspective, this would be a negative trend, as residential construction is a key consumer of steel, an industry fed by Australian iron ore exports.
The Population Problem
The UN estimates that as of last month, India replaced China as the most populous nation on earth.
A few years ago, the Indian prime minister expressed concerns about India’s “population explosion” and praised families who carefully considered the impact of more babies. In other words, families were producing too many children – a problem China addressed decades ago with its “one-child policy”.
It is the fallout from that policy that has allowed India to pull ahead.
China has now experienced a decline in population for the first time in six decades, with the national birth rate reaching a record low of 6.77 births per 1,000 people in 2022. In comparison, the birth rate in the United States during the same period was 12 births per 1,000 people.
In recent months, the Chinese government has implemented several measures to encourage marriage and childbirth.
Potential for GDP growth is a function of population and productivity growth, notes Ruchir Sharma. China’s negative population growth means fewer workers are entering the labour force, and heavy debts are slowing output per worker.
No economy has ever achieved economic growth amidst a decline in the working population, Sharma told CNBC.
The long-held view is that China will continue to gain ground rapidly on developed economies, achieving high income status and surpassing the US as the world’s largest economy within the coming decade or so.
The analysts at Capital Economics are sceptical.
Over recent decades China has followed a similar growth trajectory to Japan, Korea and Taiwan, which are among the few emerging markets that have successfully made the transition to high income status. But China is reaching the limits of investment-led growth at a much lower level of income than its north-east Asian neighbours did.
With “remarkably good” infrastructure for its income level, and an “ample supply” of modern housing, the need for further rapid growth in construction has diminished, Capital Economics suggests.
And while Japan, Korea and Taiwan were still rapidly expanding their manufacturing sectors and exports at this stage in their development, China’s share of world exports is already higher than its neighbours ever achieved, plus it is already running into a global protectionist response.
Capital Economics draws on the population problem in noting China is also growing older much sooner than its Asian peers. A declining working-age population means employment will start contracting – something that only happened to peers once they had already reached high income levels.
Although there has been some effort to move away from an emphasis on growth at all costs, China’s leaders clearly still have high ambitions for future economic performance, Capital Economics notes. They have set a GDP growth target of “about 6.5%” for this year, and a prior commitment to double GDP by 2020 relative to 2010 levels in order to create a “moderately prosperous society” implies that they will target similarly rapid growth to the start of the next decade.
No “hard” growth targets have been set for growth beyond 2020 (noting covid rather got in the way), but Xi Jinping has set goals of China being a “modern socialist country” by 2035 and a “rich and powerful socialist country” by 2050.
Implicit in this bold vision, Capital Economics notes, is that China continues its rapid climb up the development ladder, reaching high income status in the coming decades.
“The odds aren’t in his favour,” the analysts warn.
Ruchir Sharma has a warning for other analysts – the ones who remain blindly optimistic on China’s growth:
“While analysts may have little to lose from rosy forecasts, the rest of us do. ‘Boomy’ chatter has contributed to investors’ loss of hundreds of billions of dollars in China in just the past four months. Further, global growth may prove weaker than expected in 2023, since the hope is that a US downturn will be countered by the China reopening boom, which may never come.
“It is time to expose this charade before the fallout gets worse.”
China is now experiencing a new wave of covid, being the new omicron variant also turning up elsewhere, such as in Australia.
Medical experts in Australia have noted that each successive wave of covid is resulting in fewer cases than the last. The population is now up to its fifth vaccine – and specifically an omicron vaccine this time – being freely available.
China’s previous covid waves were exacerbated, experts assume, by the ineffectiveness of its homegrown vaccines, and China refused offers of the more effective mRNA vaccines developed in the US.
China is now scrambling to come up with and distribute an omicron vaccine ahead of the northern winter. The latest wave is expected to peak next month at 65 million cases.
While Australia and others have now long abandoned lockdowns and learned to “live with covid”, China’s flip-flopping policies have not provided the same result.
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