China’s economic recovery will likely gain more traction as additional policy support takes effect in the coming months. However, the economy will remain fragile because of the unrelenting weakness in the property market, continued financial stresses and weak confidence among households and private businesses.
The country’s rebound will benefit other Asian economies, but the boost may not be as great as before, given the smaller recovery and the inward turn in Chinese economic policies.
The economy should gain more momentum in the coming months. There are several reasons to feel good about the economy’s improvement. The latest data suggest that demand is steadying after a period of weakness and that the economy is rebalancing towards a more sustainable pattern.
Adding to the confidence, we find that China’s leaders are signalling even more support, which will help sustain the ongoing rebound — even if policy measures remain calibrated and cautious.
The economic numbers that were released this month were also mostly positive. Overall, economic output grew by 4.9% in the third quarter, slower than 6.3% in the second quarter but better than the markets had expected. It is a sufficient pace to allow China to achieve its target of around 5% growth this year.
The indicators for September were also encouraging:
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• The consumer can continue supporting growth: Retail sales expanded at the fastest rate since May, up 5.5% y-o-y in September after rising 4.6% in August. This is noteworthy because it reflects organic growth rather than the product of artificial government stimulus. The Chinese consumer’s spending potential is underpinned by improving incomes — urban households enjoyed growth in per capita disposable income of 4.7% in real terms. Moreover, the unemployment rate inched down to 5% from 5.2% in August and is at its lowest level since November 2021. A senior official remarked that youth unemployment, which had surged earlier in the year, had begun to stabilise as well.
• Production activities are picking up: Industrial production continued to expand by 4.5% in September, a pace similar to that in August, while output in services sectors increased by 6%. Power consumption surged by 8.2% in the third quarter, faster than the growth of 7% in the prior quarter.
• The monetary indicators also show improvement: The total amount of funds raised in the economy was up by almost a third in September as the quantum of new loans spiked. This tells us that government efforts to get banks to lend more are working, which will help raise demand in the coming months.
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These domestic factors helped to overcome the continued drag on growth from a declining real estate sector, which also caused overall investment to remain humdrum —fixed asset investment growth edged down to 3.1% from January to September from 3.2% in January to August. Exports, which fell 6.2% in September, also did not help, although this was better than the 8.8% export decline in August.
The economy is transitioning to an economy where consumers and high-value sectors drive growth, away from the over-dependence on investment and property. Out of the growth of 4.9% in economic output, consumer spending contributed 4.6 percentage points.
And, despite the weakness in overall fixed asset investment, there were bright spots in the composition of capital spending. Investment in high-tech activities — both in manufacturing and in services — grew by 11.4% in the January to September period.
Money is being deployed in future industries, such as aerospace, vehicles and medical equipment. Capital also flows into developing capacity in high-tech services such as scientific, technological and professional technical services.
This pattern of investment — sharply declining investment in real estate against surging investment in the new economy — is what China needs to move away from its excessive dependence on property.
Economy remains vulnerable
Despite the good news, the economy in China remains weighed down by serious imbalances. The immediate concern is the potential interaction among three sets of vulnerabilities — financial stresses, the continued deflation of the real estate sector and parlous confidence levels among ordinary folks and private entrepreneurs.
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More large companies are getting into financial difficulties. The latest is Country Garden Holdings, one of China’s largest property developers, which did not make timely payment on the US$15.4 million ($21 million) coupon that was due — this could potentially become a default by this giant property developer with some US$200 billion in liabilities.
So its difficulties will rattle ordinary folks who have paid upfront for homes sold by this company — the company is currently involved in more than 3,000 housing projects across the country and employs 7,000 workers, many of whom will be worrying about being paid. Also worrying would be construction companies that are waiting for payments due from it, not to mention the banks and bondholders who have lent to the company.
Another source of potential troubles is the local government funding vehicles (LGFVs). As their revenues from land sales have fallen by nearly 20% in the January to August period, there are growing doubts about their ability to service their loans and whether they can continue to deliver on their obligations to their residents in the form of welfare and other social safety net payments.
Since the central government will probably ensure that social payments will be made to avert political troubles, the lenders to the LGFVs are at risk. The country’s regional banks have been identified as the most likely casualties from the LGFVs’ difficulties as they exposed around RMB12 trillion ($2.2 trillion) to the LGFVs as of the end of 2022. S&P Global Ratings has estimated that an LGFV crisis could mean the regional banks suffer a capital shortfall of RMB2.2 trillion.
A final major vulnerability in the economy is the confidence of key economic agents, particularly households and private entrepreneurs.
• Although it is encouraging that households are spending more (as described above), they are not growing their spending in line with their incomes. Instead, they are repaying loans and increasing their savings rapidly. New deposits by ordinary folks reached an extraordinarily high level of RMB2.53 trillion in September. The savings rate of urban households was 38.3% in the first nine months of this year, not much of a recovery from the 38.8% to 41.4% rate in the pandemic years when households were scared of the future and saved rather than spent.
• Private businessmen, the other critically important set of actors in the economy, have been rattled by the ideological shift in China, emphasising the state rather than the market, the talk about “common prosperity”, and the harsh crackdowns on corruption or other misconduct. So far, the government’s soothing sounds to calm their fears and the establishment of a new agency to help private firms have only had limited effects. Private investment was down by 0.6% from January to September this year compared to the same period last year. More needs to be done to restore their confidence.
There is still a risk that these three forces — financial imbalances, real estate downturn and weak confidence in key areas — could interact to produce a sharp slowdown or unexpected stresses.
Policymakers supporting the economy
Strong indications indicate a more energetic policy response to China’s economic troubles. President Xi Jinping is reported to have made his first-ever formal visit to the People’s Bank of China, the country’s central bank, this week, accompanied by his economic czar, He Lifeng.
Although few details of this visit have been made public, Xi likely intended this visit to be a signal to government officials of the heightened priority he now accords to addressing the economy’s woes.
This happens just before the crucial Third Plenum meeting of the Chinese Communist Party’s central committee, where crucial economic matters are discussed and decided.
Additionally, the authorities revealed plans for a national financial work conference in October, the first since 2017. Considering China’s existing challenges in this area, the conference might introduce significant policy changes to stabilise it.
This week, the authorities have stepped up support for the economy. The National People’s Congress signed off on a plan to raise the fiscal deficit for 2023 to about 3.8% of gross domestic product. The willingness to exceed the 3% limit that was set in the past is a mark of the policymakers’ concern over the economy.
This will involve issuing additional bonds valued at RMB1 trillion in the coming months, financing extra spending in various areas, including disaster relief and infrastructure construction. Earlier this week, the central bank also instructed commercial banks to provide more support to the LGFVs through new loans at low interest rates.
Stresses will linger
Given the stepped-up government support for the economy, China is set to achieve its 5% growth target for this year and roughly repeat that performance in 2024. Insofar as the impact on the rest of Asia is concerned, a few things must be kept in mind.
First, the growth rebound will not be on the scale of previous Chinese cycles. Even as the headline economic numbers improve, the mood of consumers and businessmen may not pick up as much as financial and other stresses will persist for some time.
In other words, it will be a troubled recovery. Therefore, while there will be an uplift in demand for imported goods and some rise in commodity prices, the effects will be modest. Similarly, given that the Chinese are less keen to travel abroad than before the pandemic, the Chinese recovery will provide a shot in the arm for Asian tourism, but it may also disappoint.
Second, as confidence in China’s stabilisation improves, the Chinese Yuan should also firm up, relieving some of the pressure on Asian currencies. A more stable Chinese economy should also translate into improved risk appetites among global investors for emerging market assets, which in turn should help Asian markets.
Third, China’s trading partners should also note President Xi’s speech, which was only published in Chinese media. In that speech, Xi seemed to prefer that Chinese companies move lower-value production abroad — which would benefit the poorer Asian economies.
Instead, Xi appears to want low-end industries to be given technological upgrading so that they can preserve their competitiveness and remain in China. We expect some of the stimulus spending that the central government plans to be devoted to that cause.
If we extrapolate from Xi’s remarks, it also shows that Chinese leaders need China to produce more components than its Asian trading partners currently export to China.
For both security and economic reasons, China will seek to capture more value within China rather than rely on trading partners. Some economists have argued that part of the recent weakness in Chinese imports is due to producers displacing component imports from other Asian exporters.
Overall, China’s neighbours will have reason to celebrate a Chinese recovery, but they will have to get used to China not providing as much of a spillover as in the past.
Manu Bhaskaran is CEO at Centennial Asia Advisors
