As China shows sparks of recovery, it’s best not to get too excited about the improving health of Asia’s biggest economy. That’s especially true if you’re Xi Jinping and Li Qiang.
The green shoots seen in October data on China’s retail sales and manufacturing are indeed a relief to global investors and Asian policymakers. The 7.6% year-on-year jump in sales and 4.6% rise in factory output suggest stimulus efforts by President Xi and Premier Li are gaining traction.
Yet weakness elsewhere remains a clear and present danger in the homestretch of 2023.
Hopes that Xi and Li have gotten a handle on China’s property crisis are belied by the 9.3% plunge in real estate investment last month.
The same goes for signs China slid back into deflation. The other big problem: intensifying global headwinds as growth in the US, Europe and Japan disappoints.
Japan’s economy, for example, shrank 2.1% year on year in the July-September quarter, much worse than the 0.6% contraction forecasters expected. Here, Japan shows the difficulty of straddling US and Chinese economies experiencing rough patches.
The US is buckling under the weight of 11 Federal Reserve rate hikes in less than 20 months. The coming US 2024 US election cycle, meantime, will add pressure on President Joe Biden to take an even harder line on China in the form of more trade sanctions and tech curbs.
In China’s case, it’s quite possible to make a credible half-glass-full argument.
Take auto sales. In October alone, passenger vehicle sales jumped 10.2% year on year. In part, this speaks to the industry’s success in rolling out sales promotions and savvy marketing of electric and hybrid vehicles.
Yet it fits with news that in the July-September period, China managed to grow 4.9%, faster than forecasts of a 4.5% pace.
The varying speeds at which the economy is moving is to be expected as China transitions to new growth engines, explains Liu Aihua, a spokesman for the National Bureau of Statistics. It’s all part of a years-long move away from smokestack-heavy industries toward innovation and sustainability.
“Effective” policy tweaks in the economy are bearing fruit, Liu says, describing China as undergoing “wave-like development” and “tortuous progress” toward increased efficiency and productivity.
Yet the move upmarket will not always be smooth. “At present,” Liu says, “the external pressure is still great, the constraints of insufficient domestic demand are still prominent, enterprises have many difficulties in production and operation, and hidden risks in some fields require much attention.”
One such risk is the yawning income gap between urban and rural consumers. The good news, Liu says, is that by some metrics household consumption contributed 83.2% to economic growth in the first 10 months of 2023, a 6% year-on-year increase.
It’s here, though, that the urban-rural wealth divide leaves China’s economy unbalanced. Months ago, when youth unemployment topped 20%, Beijing merely stopped publishing regular statistics on the unsettling measure.
The key to raising rural incomes is diversifying growth engines far more aggressively. No effort is more crucial than reducing the outsized role that the property sector plays in generating gross domestic product (GDP).
“Clearly, the property sector remains a weak spot for the economy, which requires further support in the foreseeable future,” says Hao Zhou, chief economist at Guotai Junan International.
In recent years, real estate-related sectors provided roughly a quarter of China’s GDP. This year, economists at UBS calculate that the share has fallen closer to 22%. Even so, the sector’s chronic weakness threatens to drag down parts of the economy now showing signs of hope.
“Retail sales in October were particularly strong, beating even our above-consensus estimates,” says economist Louise Loo at Oxford Economics. But “at this juncture, we are skeptical that the now-three consecutive months of strong retail sales data are pointing to a permanent upshift in consumers’ spending propensities.”
One important caveat: Year-to-date retail sales data showed low-value discretionary items emerging as an outperforming segment, “consistent with what we think is typical of weak economic recoveries – when the consumer’s willingness to spend rests on smaller-ticket items,” Loo adds.
For China going forward, Gita Gopinath, first deputy managing director of the International Monetary Fund, tells CNBC, “the pressure remains.”
She adds that “there remains a lot of stress in the market. There remains weakness in the market. This is not going to be over with quickly. It’s going to take some more time to transition back to a more sustainable size.”
In the short run, the mixed bag of Chinese data points to the need for more assertive stimulus jolts by the central government in Beijing.
The biggest worry is the “negative wealth effect” emanating from the property market, says economist Jacqueline Rong at BNP Paribas SA. For all the excitement about firmer retail sales trends, Rong notes, the two-year average growth in sales remains well below the 8% pace before Covid-19 lockdowns.
Many local governments also may lack the fiscal space needed to boost far-flung economic regions as property markets sour far and wide.
That explains why infrastructure spending fell 0.2% in October and suggests “the damage inflicted by the housing crash is too extensive to be countered by fiscally constrained local governments,” write economists at Societe Generale in a recent report. “The 1 trillion yuan (US$139 billion) already announced does not seem to be enough.”
Lisheng Wang, an economist at Goldman Sachs, adds that “given persistent growth headwinds from the property downturn, still-fragile confidence and lingering financial risks, we think a ‘policy put’ has been triggered in China and expect the central government to step up easing materially in the coming months.”
Though topline growth is beating the odds, China’s economy is “not out of the woods by any means,” says Stephen Innes, managing partner at SPI Asset Management.
He adds that “this growth suggests a modest improvement in the Chinese economy. However, there are ongoing calls for increased policy support to maintain consistent growth, as there are concerns about the sustainability of the recovery.”
There are concerns about the progress of reforms, too. For all the success Xi’s Communist Party has had in juicing GDP, officials have made little progress in building the robust safety nets needed to stabilize the economy. And to encourage households to save less and spend more.
Making consumption a bigger share of GDP is the key to allowing Beijing to throttle back on fiscal policy and local governments to rely less on leverage. It’s central to phasing out the gigantic shadow-banking system and letting the People’s Bank of China (PBOC) withdraw massive stimulus from the economy.
The need for a recalibration from over-investment to consumption was well-known even before Xi rose to power in 2012. So was the need to create broader safety nets across sectors.
But time and time again, the hard work of engineering took a backseat to short-term considerations. The tendency has been to pour more public works spending into new infrastructure and property. These investments in hardware come at the expense of the economic software needed to raise China’s competitiveness.
This happened after the 2008 global financial crisis. Delay was the response to the 2013 Fed “taper tantrum.” The same with the chaotic summer of 2015, when Shanghai stocks lost a third of their value in just three weeks.
The Covid-19 pandemic deadened Beijing’s reformist instincts. In fact, it was at the height of the pandemic that Xi began his clampdown on Big Tech, starting with Alibaba Group’s Jack Ma. The US Fed’s most aggressive tightening cycle since the mid-1990s hardly helped.
Yet since reopening from the Covid era, Xi’s government is finding that the consumption rebound isn’t what Beijing hoped.
From a policy standpoint, the months ahead will be quite a balancing act. Since he took over as premier in March, Li has prioritized deleveraging over excessive stimulus so as not to incentivize a return to bad lending behavior.
This includes guarding against a major plunge in the yuan that might increase the odds of property developers defaulting on offshore debt.
On Monday (November 20), the PBOC left benchmark lending rates unchanged at a monthly fixing. While many economists think China could do with more policy stimulus, the PBOC is holding the one-year loan prime rate at 3.45% and the five-year LPR at 4.20%.
“Policymakers may want more time to assess the impact of the recent repricing of existing mortgage contracts before they make further changes to the benchmark rate,” says Julian Evans-Pritchard, head of China economics at Capital Economics.
“The big picture though is that, with economic momentum weak and downward pressure on the renminbi reversing, we think rate reductions will come before long.”
Accelerating reforms is even more important to restoring confidence among mainland households and foreign investors alike. Today’s green shoots might prove fleeting without major upgrades that build economic muscle for the long run.
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