The at least $17.7 trillion Chinese economy has been facing a slowdown recently, which is hard to miss due to China’s global trade and investment connections. China slipped into deflation for the first time in more than two years, official data showed on 9 August.
The IMF expects China’s economy to expand 5.2 per cent this year after a 3.0 per cent increase in 2022; quarter-on-quarter growth from Q1 to Q2 in 2023 was merely 0.8 per cent.
A set of political and market factors structurally prompts the current deflationary trend in the country.
Political decisions at the State level on investment and exports-driven growth models, government intervention in business establishments, and a turbulent external environment using large-scale stimulus to boost demand have led to structural challenges over time.
Witch hunts against private entrepreneurs, entertainment industry icons, technology industry leaders, and foreign executives, a zero-covid policy, picking fights with neighbours, and trade wars contributed to the rollback of China’s global multilateral trade.
Excessive and personalised style of government control discouraged new foreign companies from setting up bases in China.
A massive oversupply in property and industry and surging debt levels among local governments, in combination with sluggish consumption, sagging exports, record youth unemployment, and a shrinking population, has put a massive strain on State finances.
Emergence from a ‘Zero COVID’ policy induced a slowing GDP growth, a dangerously low level of consumption, and a saving habit among the general public rather than spending on goods and services once considered essential.
About 25 per cent of GDP comes from real estate, which has not been doing well for the last two years and is connected to more subsidiary and dependent industries such as construction, finance, and marketing than any other sector.
Real estate accounts for 76.4 per cent of the debtor assets of listed banks with mortgages exceeding 10 trillion Yuan. Data from the Ministry of Finance showed that the size of the nation’s land transfer premiums grew to 6.5 trillion Yuan in 2018 and that these sales now account for 66.5 per cent of local government revenue.
Real estate investment was down more than 10 per cent year-on-year in 2022. Halfway through 2023, investment is already down 8.5 per cent year-on-year. More than 60 per cent of companies in the sector that have published performance reports for the first half of 2023 expect to make a net loss this year.
China’s shadow banking system, equivalent to US$ 3 trillion, almost the size of the British economy, has invested heavily in real estate. The fall in demand and property prices, which before the advent of COVID was the mainstay of the Chinese economy, has led to shadow banks defaulting on payments.
The shadow banks, which also raised money directly from wealthy investors and corporate treasuries, lent to local government vehicles, property developers, and other borrowers that couldn’t otherwise obtain traditional credit.
Evergrande Group, the benchmark of China’s real estate sector and once a ‘trillion-dollar empire’, went into crisis in 2021 and filed for bankruptcy protection in the US on 17 August, its liabilities are roughly equivalent to almost 2 per cent of China’s GDP.
Evergrande, in a letter to local authorities in 2020, had said that the cash crunch could lead to substantial financial and social risks with over 600,000-odd unfinished apartments in the coming years.
On 12 August, another ‘model’ real estate giant, Country Garden, announced suspension of its 11 domestic corporate bonds and failed to pay the coupon of two US dollar bonds that should have been paid on 7 August.
As sales continue to tank and new financing remains in short supply, construction of about 10 per cent of homes sold in 2021 in 24 major cities has stalled.
The protest by the homebuyers extends the risk of defaults from offshore developer bonds to banks with US$6 trillion of home loans.
China’s largest private asset management company/shadow bank, Zhongzhi Group’s subsidiary Zhongrong Trust, also began to default on payments. The firm has been facing losses since 2021.
Since the local governments incur the majority of the debts in infrastructure, they have acted forcefully compared to the opaque central government.
On 3 August, the Zhengzhou city government introduced ‘15 articles’ to save local real estate firms through tax cuts, cancellation of sales restrictions, and implementing policies such as “recognising houses but not mortgages.”
The crackdown on private business establishments also took away a lucrative career path for many young, ambitious graduates.
A 2019 Chinese Academy of Social Sciences report predicted that the country’s leading pension fund would run out of money by 2035, partly because of the shrinking workforce.
The COVID lockdown and subsequent supply disruptions led to a large-scale shortage in electronic goods supply from China, impacting the industry.
What statistics say
The Yuan’s China Foreign Exchange Trade System basket has fallen every week since late April. China’s Consumer Price Index (CPI) fell by 0.3 per cent in July, and the producer price index (PPI) fell for a 10th consecutive month.
China’s private Caixin/S&P Global manufacturing purchasing managers’ index (PMI) rose to 51.0 in August from 49.2 in July. Still, an official survey showed manufacturing activity contracted for a fifth straight month in August, offering a mixed picture.
China’s foreign trade, accounting for one-third of GDP, was down 4.7 per cent year-on-year. Exports to two of China’s biggest markets, the US and EU, have slumped significantly due to inflation.
China’s household debt is now at 63.5 per cent of GDP, getting close to the 65 per cent red line previously used by the IMF as a marker warning of financial risks.
In August statistics, the real estate sector showed a slight resilience due to the government’s 25 per cent increase in railroad spending through the first half of the year.
The firms loading up on iron ore to prepare for a ‘possible’ post-summer construction boom helped maintain the iron ore prices above US$100 per ton for most of 2023.
There is also continued demand for power machinery, cars, and shipping materials, which has partially made up for fallen iron demand in property construction.
In the first half of 2023, developers spent 10 per cent less on land year-on-year, and sales by the value of the top 100 developers rose only 0.1 per cent year-on-year. Officially, from January to July, property investment in China fell 8.5% — a blow to local governments since they earn 30 per cent of revenue from land sales.
Borrowing was down another 13 per cent in the first five months of this year, indicating fewer people are taking out new mortgages.
Interestingly, China’s Bureau of Statistics suspended the publication of unemployment data in August, claiming that it had encountered “technical difficulties”. The real reason could be the impact feared by the ‘July graduation wave’ of young students.
Cumulative growth in fixed asset investment in July was 3.4 per cent, a sharp slowdown from 5 per cent in March.
Residential consumption experienced a rebound, with a growth rate peaking at 18.4 per cent in April, and then began to decline exponentially, with consumption growth of only 2.5 per cent in July.
Total sales of consumer goods showed growth for only the essentials of life, such as food, cigarettes, alcohol, and medicines; it declined for other commodities.
The credit-to-GDP ratio, an indicator of a crisis, has been among the highest in China. Though the recent price decline is not as sharp as in 2011 and 2015 when China almost went to the verge of a crisis, the Xi Jinping government’s focus on a ‘Zero COVID’ policy prevented it from implementing a bailout.
The number of unemployed people aged 16 and 40 has increased by 6.2-7.5 per cent compared to pre-pandemic levels. The unemployment rate for young people aged 16-24 was 21.4 per cent in July.
A shrinking population will likely exacerbate China’s problems with an ageing workforce and drag on growth.
China’s social security system is likely to be strained as there will be fewer workers to fund things like pensions and health care.
Xi Administration’s action
The regime issued a ‘Notice on Expansion of Consumption,’ colloquially referred to as ‘Twenty Articles,’ to expand consumption, but with no subsidies or consumption vouchers, it has done little.
From January to July, China’s fixed asset investment rose by 3.4 per cent, but the private investment component of this fell by 0.5 per cent, weakening through the months. This indicates that the Party-state’s outreach to the private sector has failed to revive confidence.
Chinese regulators like the China Banking and Insurance Regulatory Commission (CBIRC) have urged banks to increase lending to developers so they can complete unfinished housing projects.
But cuts in interest rates and down-payment requirements may not compensate for massive oversupply in the property sector.
Poor employment growth is a consequence of the private sector’s woes since it accounts for over 80 per cent of urban jobs. This further feeds into the consumption challenge.
Impact on other countries
Japan, South Korea, and Thailand have already registered a drop in exports and services due to slowing demand in China.
Facing rising labour costs in China, many companies have already begun shifting their manufacturing operations to lower-paying countries like Vietnam, India, and Mexico.
A better-educated workforce and a shrinking population of young people — could raise costs for consumers outside China, potentially exacerbating inflation in countries that rely heavily on imported Chinese products.
Lesser demand in China could drive commodity prices soaring, including that of oil.
A shrinking population would also lead to declining spending by Chinese consumers, threatening global brands of smartphones and sports goods.
A slower China means less demand for commodities and imports and less geopolitically-driven Chinese investments and influence in places like Africa.
It would also mean a drawback for the countries involved in the Belt and Road Initiative (BRI). Italy is already shaping its new foreign policy initiative to limit technology transfers to China.
Further, Rome recently announced that it intends to withdraw from the BRI deal “since it did not meet expectations”. This could damage China’s plans as Italy was the only G7 nation to have been a part of the BRI.
Still, China is assertive on defence spending; its military might continue to increase, its diplomacy is global, and it is a party to economic arrangements that the United States is not. More countries aiming to join BRICS also indicate that China is still going strong in diplomacy.
Since Chinese financial markets are not as well integrated with the rest of the world as their trade sector, the spillovers will remain limited to the trade channels.
The writer is the chairman of New Delhi-based think-tank Law and Society Alliance. Views expressed in the above piece are personal and solely that of the author. They do not necessarily reflect Firstpost’s views.
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