China proud Rely on firm, “sticky” leadership and steady economic growth. That should make its fate easy to predict. But the world’s second-largest economy has been full of surprises in recent months, catching seasoned China watchers and astute investors alike off guard.
For example, in the first three months of the year, China’s economy grew faster than expected due to its unexpected and sudden escape from the covid-19 pandemic. Then in April and May, the opposite happened: the economic recovery was slower than expected. Data on retail sales, investment and property sales all missed expectations. Unemployment among China’s urban youth has risen to more than 20%, the highest level since data records began in 2018. Some economists now think the economy may not grow at all in the second quarter compared to the first (see chart). According to Lu Ting of Nomura Bank, this can be counted as a “double dip” by Chinese standards.
China also defied the third prediction. Thankfully, it failed to become an inflationary force in the world economy. Its increased demand for oil this year has not prevented the cost of global benchmark Brent crude from falling more than 10% from its peak in January. Steel and copper have also lost value. China’s producer prices (ex-factory prices) fell more than 4% in May compared with a year earlier. And the yuan has depreciated. The price Americans paid for goods imported from China fell 2% in May from a year earlier, according to the U.S. Bureau of Labor Statistics.
Much of the economic slowdown can be traced to China’s real estate market. It appeared to be recovering from disastrous defaults, plunging sales and a mortgage boycott earlier this year. The government has made it easier for indebted property developers to raise funds so they can complete long-delayed construction projects. Households that didn’t buy during China’s sudden lockdown last year are back on the market in the first months of 2023 to make purchases they’ve put off. Some analysts even worry that the housing market may rebound too strongly, reviving past speculative momentum.
But that pent-up demand appears to have evaporated. Based on a population-weighted index of 70 cities and seasonally adjusted by Goldman Sachs, new home prices fell in May from the previous month. While property developers are once again keen to complete construction projects, they are reluctant to start them. Consultancy Longzhou Economics calculates that property sales have fallen back to 70% of levels seen in the same period in 2019, China’s last relatively normal year. Housing starts are only around 40% of 2019 levels (see chart).
How should the government respond? In worrisome weeks, it was unclear whether it would respond. Its growth target for this year — about 5 percent — lacks ambition. It appears keen to rein in local government debt, which is often urged to spend profligately in the interests of economic growth. People’s Bank of China (People’s Bank of China), the country’s central bank appears to be indifferent to falling prices. It may also worry that rate cuts will unduly squeeze banks’ profit margins, since the rates they pay on deposits may not fall to the rates they charge on loans.
But on June 6 People’s Bank of China The order for the country’s largest bank to cut deposit rates paved the way for the central bank to cut its policy rate by 0.1 percentage point on June 13. The cut itself is negligible. But it shows that the government has not forgotten the danger. The rates banks charge to “prime” customers are likely to fall next, which will further reduce mortgage rates. On June 16, the State Council meeting of the Chinese cabinet hinted at further steps. (see chart).
Robin Xing of bank Morgan Stanley expects further rate cuts. He also believes that restrictions on home purchases in first- and second-tier cities may be eased. The country’s “policy bank” is likely to lend more for infrastructure. Its local governments may be allowed to issue more bonds. China’s budget indicates that land sales are expected to remain stable in 2023. Instead, year-to-date revenue is down about 20% compared to the same period in 2022. If the shortfall lasts for a full year, local governments will lose more than 1 trillion yuan ($140 billion) in revenue, Xing noted. The central government may feel obliged to fill this void.
Is this enough to meet the government’s growth targets? Mr. Xing thought so. He sees the slowdown in the second quarter as nothing more than a “quick issue”. According to Xing’s calculations, there are 30 million fewer people employed in China’s service sector this year than they would have been without the pandemic. A rebound in “contact-intensive” services such as restaurants will restore 16 million of these jobs over the next 12 months. (In other North Asian economies, he noted, it took two to three quarters for such employment to recover after the initial reopening.) When jobs do recover, income, confidence and spending will recover.
Another 10 million jobs are in sectors such as e-commerce and education, which have been hit by a regulatory storm in 2021 aimed at curbing market abuses, closing regulatory loopholes and reasserting party prerogatives. China has softened its attitude towards these companies in recent months. That may encourage some of them to resume hiring as the economy recovers.
Other economists are less sanguine. Xu Gao of BOCI believes that further monetary easing will not work. Loan demand is insensitive to interest rates because the economy’s two largest borrowers — property developers and local governments — are weighed down by debt. The authorities cut interest rates more out of desperation than hope.
He may be right. But it would be weird to assume that monetary easing won’t work until it’s actually tried. Loan demand is not the only avenue to revive the economy. Zhang Bin of the Chinese Academy of Social Sciences and others pointed out in a thought experiment that if the central bank’s policy interest rate is lowered by 2 percentage points, China’s interest payments will decrease by 7.1 trillion yuan, increasing the value of the renminbi. The stock market rose 13.6trn yuan, boosting housing prices and boosting homeowners’ confidence.
If monetary easing doesn’t work, the government will have to explore fiscal stimulus. Last year, local government financing platforms (Local government financing platforms), state-backed quasi-commercial entities boosted investment spending to shore up growth. However, this has left many of them strapped for cash. Only 567 had enough cash on hand to cover short-term debt, according to a recent survey of 2,892 of those vehicles by research firm Rhodium Group.In the cities of Lanzhou, the capital of Gansu province, and Guilin, a southern city known for its picturesque karst mountains, interest payments are made by Local government financing platforms Rise to more than 100% of the city’s “fiscal capacity” (defined as fiscal revenue plus net cash flows from financing instruments). Their mountain of debt is not a pretty picture.
If the economy therefore needs a stronger fiscal stimulus, the central government will have to design it itself. In principle, such a stimulus could include increased pension spending as well as consumer giveaways such as electric car tax breaks that would help boost car sales.
The government could also experiment with the kind of high-tech consumer goods that some cities in Zhejiang Province pioneered early in the pandemic. They distributed millions of coupons through their e-wallets, for example, if the coupon holder spends at least 210 yuan in a week, they can get 70 yuan off when dining at restaurants. According to Li Zhenhua of Ant Research Institute and his co-authors, the coupons are small but pack a punch. Every time they take out 1 yuan of public funds, they have more than 3 yuan out of their own pockets.
Unfortunately, China’s fiscal authorities still seem to view such handouts as frivolous or profligate. If the government is going to spend or lend money, it wants to create a durable asset for its troubles. In practice, therefore, any fiscal push will likely require more investment in green infrastructure, intercity transport and other public assets favored by China’s five-year plan. That would be an entirely unsurprising reaction to China’s surprising year. ■