China’s Economy Is Slowing. Here’s why that Matters

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This was meant to be the year China’s economy, unshackled from the world’s strictest Covid-19 controls, roared back to help power global growth. Instead, it’s facing a confluence of problems: Sluggish consumer spending, a shaky property market, flagging exports amid a US drive for “de-risking,” record youth unemployment and towering local government debt. The impact of these strains is starting to be felt around the globe on everything from commodity prices to equity markets. What’s worse, President Xi Jinping’s government doesn’t have great options to fix things. That’s sparked a discussion about whether the Chinese economy is headed for a Japan-style malaise after 30 years of unprecedented growth.

 

  1. How bad is China’s economy?

 

China’s official target is for growth of around 5% this year. In a world economy expected to grow a meager 2.8% in 2023, that doesn’t look too shabby at first glance. The reality, though, is that China was still under Covid Zero rules in 2022, which gives a low base for comparison. Netting out that effect, growth for 2023 will look closer to 3% — less than half the pre-pandemic average, Bloomberg Economics said. In addition China’s consumer inflation rate was flat in June while factory-gate prices fell further, fueling concerns about the risk of deflation — a damaging downward price spiral that can wreck an economy.

 

  1. Why is that a problem?

 

A lot of the world’s jobs and production depend on China, with its vast market and factory floors. The IMF forecasts China will be the top contributor to global growth over the next five years, with a share expected to represent 22.6% of total world growth — double that of the US. A main way China’s expansion has an impact on businesses across the world is through trade, and mineral-exporting countries such as Brazil and Australia are particularly susceptible to China’s infrastructure and property cycles. Prices of key commodities including steel rebar and iron ore futures fell this year as demand in the world’s biggest consumer of metals didn’t pick up as strongly as traders had expected. The slump is hitting exporters of high-tech goods especially, with shipments from South Korea and Taiwan dropping by double digits each month in the first half of the year. After years of Covid restraints, Chinese travelers have yet to resume traveling en masse abroad, as their income and job confidence remains weak, hurting tourism-dependent countries. With the risk of further interest rate hikes tipping the US into recession, the prospect has grown of the world’s two economic powerhouses slumping simultaneously, compounding the pain for everyone.

 

  1. Where is the trouble?

 

China’s $18 trillion economy has been struggling across a range of sectors. Data released at the end of June showed manufacturing activity contracted again. Exports — a consistent support during the pandemic as Chinese factories rushed to fill US and European orders — have dwindled. Since peaking at a record $340 billion in December 2021, exports were down to $284 billion in May as rising interest rates weigh on economic activity in the US and Europe. Exacerbating the situation are US efforts to cut China off from supplies of advanced semiconductors and other technologies set to drive economic growth in the future — what officials in Washington call “strategic competition” and China decries as “containment.” China’s total imports of goods dropped 6.7% on an annual basis in the first five months of this year, after edging up 1.1% in 2022. Hidden debt at so-called local government financing vehicles (LGFVs) poses another strain for some cash-strapped cities and counties. Municipalities ramped up such off-book borrowing during the pandemic as a more traditional source of revenue — land sales to property developers — dried up due to the housing downturn. In a scenario where property construction crumbles, reduced land sales hit government spending, a US recession weakens global demand and China’s markets shift to risk-off mode — where traders focus on protecting capital — Bloomberg’s SHOK model shows another 1.2 percentage points shaved off of China’ growth.

 

  1. Where are the post-Covid shoppers?

 

At the start of 2023, optimism was high that China would see a rapid recovery in consumer spending, fueled by revenge shopping, eating out and travel. But over the first half of the year, anxiety about what weaker growth means for unemployment and incomes, as well as the negative wealth effect from a slumping property sector — people feel their homes are worth less — prompted people to save rather than spend. Domestic travel spending during the June holiday for the dragon-boat festival was lower than pre-pandemic levels, and June car sales fell from a year ago. Another big drag on consumption is youth unemployment of 20.8% — four times the national urban rate. That’s partly to blame on Beijing’s regulatory crackdown on big technology companies in recent years, which took away a lucrative career path for many young, ambitious graduates.

 

  1. What’s going on with property?

 

The government attempted to crack down on heavily indebted real estate developers in 2020 to reduce the risk to the financial system. That pushed housing prices down and a number of weaker companies defaulted. Many developers stopped building houses they had already sold but hadn’t yet delivered, prompting some home owners to stop paying their mortgages. This turbulence was a wake up call for many Chinese, who have long considered property a sure-bet investment and used it as a store of wealth. Policymakers rolled out a rescue plan late last year, but that failed to unleash a buying frenzy. As of mid-2023, prices of new and second-hand homes had fallen every month for more than a year, but there was no indication that the decline has attracted the new buyers needed to kickstart a rebound. Banks advanced the smallest amount of longer-term loans to households last year in almost a decade and borrowing was down another 13% in the first five months of this year, indicating fewer people are taking out new mortgages. In July, China said it would extend policies to support cash-strapped developers and shore up the ailing sector, including allowing the postponement of loan repayments by a year.

 

  1. What is China’s government doing?

 

The People’s Bank of China cut interest rates in June, a traditional tool to help growth. The surprise move raised expectations for more monetary and fiscal stimulus. Possibilities being raised include a further easing in property restrictions, tax breaks for consumers, more infrastructure investment and incentives for manufacturers, especially in the high-tech sector. But as of early July, policy changes have been largely incremental, such as extending tax breaks for new energy vehicles through 2027. High public debt levels and Xi’s efforts to curb property speculation — part of his “common prosperity” drive — could constrain any big spending plans. The biggest state banks have started offering LGFVs loans with ultra-long maturities and temporary interest relief to help avert a credit crisis, Bloomberg News reported in July. Some cities have lowered down-payment requirements and removed restrictions on buying multiple properties to help revive the property market.

 

  1. What are the prospects for China’s economy?

 

Massive oversupply of housing means it will take a while for any property stimulus to flow through to actual construction, if it does at all. With a shrinking population and slowing urbanization, there are fewer structural factors driving housing demand in China as well. That means the country could face an extended period of weak growth while it works out its debt problems, just as Japan did in its so-called “lost decade,” after the property and stock market bubbles there burst. Altogether, the dynamics threaten to thwart China’s momentum to surpass the US as the world’s biggest economy, which had been seen possible as soon as the early 2030s.

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