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2023 was anticipated as the year of a vibrant Chinese economy bounce-back. The lifting of strict Covid-19 measures was hailed as the biggest economic event of the year. However, the narrative has shifted.
China’s second-largest economy witnessed a modest growth of 0.8% in the second quarter, compared to 2.2% in the previous three months. Various indicators, including industrial activity and business investment, also suggest a gloomy outlook for the coming months. This prompts investors to question whether China’s recovery has already come to an end.
Several factors contribute to this sluggishness. Firstly, China’s export-dependent economy faces weakened demand for its products due to high interest rates affecting advanced economies. Additionally, consumer preferences have shifted away from goods like consumer electronics, which enjoyed a surge during the pandemic. Western consumers now allocate more of their spending to restaurants and vacations. Consequently, China’s economy, which accounts for nearly a third of global manufacturing output, is strained.
Secondly, consumer confidence within China remains weak. Although savings increased during the pandemic, retail sales have been underwhelming. Falling housing values have diminished homeowner wealth, while potential buyers are hesitant. New home prices are on track to experience the longest fall since 2011. Furthermore, the economy is burdened by high unemployment rates among graduates, surpassing 20% for the youth population.
Lastly, business investment is in a slump. President Xi Jinping’s regulatory crackdown on tech firms, combined with geopolitical tensions with the US, has amplified uncertainty. Private fixed-asset investment contracted by 0.2% in the first half of the year, while state entities witnessed an 8.1% growth in investment. The real estate sector, which has been a driving force behind China’s economy for the past two decades, has also suffered a decline.
Despite the prevailing gloom, most analysts still anticipate the Chinese economy to grow by over 5% this year, making it a crucial driver of global economic growth as the US and eurozone economies slow down. Investors are hopeful that the Communist Party will take action to stimulate the economy.
Unfortunately, there is limited fiscal space available. Local government debt amounts to around $9tn, nearly half of the total gross domestic product. As China flirts with deflation amidst weak domestic demand, the cost of servicing such massive debt could rise. In June, China reported a 0% annual inflation rate.
Government policies shoulder much of the blame for this slowdown. Decades of relying on an investment-driven growth model have hindered the transition to a consumer-based economy. Poor oversight of the housing market contributed to an unsustainable lending boom, while political obstacles have hindered private enterprises. The strict Covid-19 restrictions have also left lasting scars.
To prevent a damaging deflationary cycle from becoming entrenched, the government must act swiftly. Providing stability and regulatory clarity to entrepreneurs and established businesses is a crucial starting point. Further loosening of monetary policy by China’s central bank could also bring relief. Beijing will also need to address the restructuring of local government debt, including the consideration of selling state assets to private companies as a potential solution. The proceeds from such a sale could help local authorities steer clear of a debt crisis.
There is hope that China’s ruling politburo will unveil additional support measures during an upcoming meeting this month. Having been instrumental in creating the current situation, it is now their responsibility to find a way out and set the economy on a better path.
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