China’s economy needs active intervention by policy makers. If timely and articulated well, growth can outperform.
China’s economy continues to make daily headlines for all the wrong reasons. Alternating between plunging exports, stagnant domestic demand, and the potential collapse of its shadow banking system, risks opined on in the press are wide ranging and acute. Authorities meanwhile have continued to focus on their structural reform agenda, remaining passive in their support, in stark contrast to prior cycles. Why do authorities remain sanguine as the market roils? Are they justified in doing so?
Exports to the west have built China’s industrial capacity over decades. So the near 15% plunge in goods exports over the year to July raised significant concerns, particularly amid talk of foreign companies relocating production from China. However, what has been missed by the market is that the recurring goods trade surplus is still roughly twice the average of 2018 and 2019. The geographic exposure of Chinese exports also continues to broaden, with fast-growing Asia taking up the slack created by weak US and European demand.
While the 12% decline in imports over the year to July sparked concern over investment, the fixed asset investment data instead points to capacity renewal and expansion across manufacturing. Though property fixed asset investment was down 8.5% year-to-date at July, investment in manufacturing was up 5.7% having averaged a similar pace between 2019 and 2022. Underlying this result, key high-tech sub-industries continue to grow investment between 10% and 40% year-to-date thanks to demand related to Asia’s economic development and the global green transition.
These outcomes are important to highlight because, while many intently focus on the parts of China’s old economy that are wilting under the weight of debt and structural reform, China’s aggregate capacity and productivity continue to grow. Growing earnings for industry mean debt deflation and/or a balance sheet recession need not lay in wait for China, as long as gains from trade flow to consumers.
This is the first of two critical issues which require careful assessment. Very little detail is provided on the state of China’s labour market, particularly now the youth unemployment rate has been suspended. What we can see clearly from the NBS PMI detail however is that, while employment growth in the manufacturing sector is just below average, for services it is significantly below.
This is a major concern because services demand is the way in which trade gains filter through to the broader economy, building up household income and providing many University graduates an avenue to build fulfilling careers. But, in a developing economy, when momentum in manufacturing and investment does not flow to services, development is hamstrung. In such an environment, aggressive precautionary saving is an entirely rational response amongst consumers, as is avoiding risk taking with respect to career and investments.
The second critical concern for China is the structural state of China’s housing market and financial system which is amplifying the effect of labour market weakness. While new home prices are managed by authorities, existing home prices are not and currently show a much greater degree of weakness.
Simply put, if you are experiencing a decline in your wealth and are uncertain how long it will continue for, you are unlikely to spend freely on discretionary items. Households desiring a property also refrain from committing to a purchase in circumstances like these.
As we’ve seen over the past year, this is not only an issue for current momentum but also the economy’s structural health. Many private developers now find themselves with liquidity and reputational deficiencies, and some solvency concerns. Numerous local governments also lack the capacity to invest while land sales to property developers remain scarce. These developments are also mounting pressure on non-bank lenders whose investment products make up a material portion of middle-to-high income households’ financial wealth.
With financial risk having spread from private developers to local governments; non-bank lenders; and back to households, there is clearly an immediate need for authorities to act decisively to avoid all the good work by exports and investment being offset.
What form should this action take? To benefit both employment and confidence, demand for new property and household consumption needs to be encouraged via easier financing terms and a further push by local governments in utilities and other infrastructure spending.
At the same time, trust must be restored in the financial system. This will take liquidity provision to bank and non-bank lenders; the reorganization of local government debt wherever it is inhibiting essential services and investment; and liberal support from the banking sector for both state-owned and private developers to allow them to attract new commitments. This seems an immense and complex agenda; but with many components already in place and others used regularly in the past, once there is the will to engage actively with the economy, quick implementation will follow.
To be clear, success will allow Chinese growth to sustain a circa 5% pace for a few more years before easing slowly to around 4% near the decade’s end. Failing to act risks growth instead jolting down to 4% or below in 2024 and 2025, with demographics and debt weighing further from there. The lower growth path would likely prevent authorities’ medium-term prosperity goals being reached and, with youth unemployment as high as it is, also risks political instability in coming years. Clearly then, there is now a political as well as economic imperative for China’s central Government to act swiftly. The next few months will determine which path China takes.
