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Friday, December 22, 2023

A Brief Report on China’s Economy

The $18 trillion Chinese economy has been spiralling down for quite some time now and owing to China’s global trade and investment connections, it becomes more than important to dive deep into the causes and effects of such a decline. According to data from the National Bureau of Statistics (People’s Republic Of China), China slipped into deflation for the first time in more than two years as the Consumer Price Index (CPI) declined by 0.3 percent in July,2023. The Chinese exports fell by 14.5% in July which was the steepest drop in last three years. Such deflationary trends in the country are a result of structural problems prompted by political and market factors :

  • After a 3.0% increase in growth in 2022; IMF data expects Chinese economy to expand by 5.2% this year, although the quarter-on-quarter growth from Q1 to Q2 in 2023 was merely 0.8 percent.

(Share of China in world GDP)

Factors for the current slowdown

  • Over time, structural issues have arisen as a result of over centralisation of power at centre leading to political decisions in matter of investments and exports-driven growth model coupled with a turbulent external environment employing large-scale stimulus to boost demand.
  • An unintelligent Zero-Covid policy, geo-political disputes with almost all its neighbours, trade wars, strict regulations & lack of ease of doing business, and harrassment of private entrepreneurs, entertainment industry icons, technology industry leaders, and foreign executives have led to the fall of China in global multilateral trade and simultaneously discouraged new foreign companies from setting up bases in China.
  • State finances are strained due to a excessive oversupply of industry and property, rising debt levels among local governments, sluggish consumption, falling exports, skyrocketing unemployment and a rapidly declining young population.
  • Recovering from the zero covid policy meant a slow GDP growth due to low level of consumption and increased saving habits among the masses.
  • A major chunk of the Chinese GDP (25%) comes from the real estate sector, which is in doldrums for the last two years. Its connection to more subsidiary and dependent industries (e.g. construction, finance, marketing, etc.) makes it more prone to risk and losses which is proven by the fact that real estate accounts for 76.4% of the debtor assets of listed banks with mortgages exceeding 10 trillion yuan.
  • In 2022, the investments in real estate sector fell by more than 10% on an year-over-year basis. Investments are already down by 8.5% halfway through 2023. More than 60% of the sector’s businesses that have released performance reports for the first half of 2023 anticipate losing money this year.

(Change in real estate/property prices in China)

  • The fall of China’s real estate sector had a domino effect on China’s shadow banking system as it invested heavily in real estate. The fluctuations in demand and property prices led to shadow banks defaulting on payments. This banking system, equivalent to $3 trillion, also raised money directly from rich investors and corporate treasuries, and went on to lend to local government vehicles, property developers and other borrowers that couldn’t otherwise obtain traditional credit.

The doom of China’s real estate sector started when Evergrande Group, the benchmark of China’s real estate industry and formerly a “trillion-dollar empire” faced financial troubles in 2021. It filed for bankruptcy protection in the United States on August 17, 2023, with liabilities roughly equivalent to nearly 2% of China’s GDP.

On 12th August, another ‘model’ real estate giant, Country Garden, declared the suspension of 11 domestic corporate bonds and skipped the coupon payment for two US dollar bonds due on August 7th.

  • Construction of around 10% of the homes sold in 2021 has paused in 24 major cities as sales continue to decline and new finance remains scarce. Due to widespread protests by the homeowners, banks holding $6 trillion in mortgage loans are now at risk of defaulting on bonds issued by offshore developers.
  • Zhongrong Trust, a division of Zhongzhi Group, is China’s biggest private asset management business/ shadow bank which also incurred losses since 2021.

Major debts in infrastructure have forced the local governments to take serious actions compared to the opaque central government.

  • On August 3rd, the municipal administration of Zhengzhou unveiled “15 articles” in an effort to save the regional real estate companies by lowering taxes, removing sales limitations, and enacting laws like “recognizing houses but not mortgages.”
  • The crackdown on private business establishments have furthered the prevailing unemployment for many fresh graduates which is very serious because according to a 2019 study by the Chinese Academy of Social Sciences, the major pension fund of China will run out of money by 2035 due to the declining labor force.

What statistics say

  • The China’s Foreign Exchange Trade System’s Yuan basket has fallen every week since late April.
  • China’s Consumer Price Index (CPI) fell by 0.3 in July and Producer Price Index (PPI) fell for a 10th consecutive month.
  • A mixed picture emerged when China’s private Caixin/S&P Global manufacturing purchasing managers’ index (PMI) increased to 51.0 in August from 49.2 in July. However, an official survey revealed that manufacturing activity declined for a fifth consecutive month in August.
  • In the first seven months of 2023, China’s imports and exports totaled $3.4 trillion USD which is a decrease of 6.1%.
  • China’s exports, which make up one-third of its GDP, decreased by 4.7% in comparison to last year. Due to inflation, exports to the US and EU, two of China’s largest markets have also declined drastically.

(Share of China in world exports)

  • China’s household debt is now at 63.5% of its GDP, which is nearing to the 65% red line previously used by the IMF as a marker warning of financial risks.
  • In August, due to the government’s 25% increase in railroad spending and businesses stockpiling iron ore in anticipation of a “possible” post-summer construction boom helped to keep iron ore prices above $100 per ton for the majority of 2023 and hence, the real estate sector displayed a slight resilience. However, demand for vehicles, shipping supplies, and power equipment is still high which is somewhat offsetting the decline in demand for iron in the building of new homes.
  • Developers spent 10% less on land in the first half of 2023 compared to 2022, while the top 100 developers’ sales by value barely increased by 0.1%. China’s official real estate investment dropped by 8.5% from January to July, which is bad news for local governments as land sales account for 30% of their earnings. Borrowing was down by 13% in the first five months of 2023, indicating fewer individuals 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”. Real reason could be the impact feared from the ‘July graduation wave’ of young students and the ever increasing unemployment.
  • Investment in fixed assets grew cumulatively by 3.4% in July, a steep decline from 5% in March.
  • Residential consumption recovered, reaching a growth rate high of 18.4% in April, before starting to rapidly drop and growing only by 2.5% in July.
  • Only essential commodities such as food, cigarettes, alcohol, and medications saw rise in total consumer purchases; other items saw declines in sales. The credit to GDP ratio, an indicator of a crisis, has been one of the highest in China. Though the recent price decline is not as sharp as in 2011 and 2015 (when China almost went on the verge of a crisis), the government’s focus on the unscientific zero-covid policy failed it from implementing a bailout.
  • When compared to pre-pandemic levels, the total number of unemployed persons between the ages of 16 and 40 has grown by 6.2 to 7.5%. In July, the unemployment rate for young adults (16 to 24) was 21.4%.
  • China’s ageing workforce will undoubtedly become a demographic nightmare as the Chinese population continues to decline and will further result in slower economic development. As there will be fewer employees to pay for things like pensions and healthcare, China’s social security system is going to be heavily under pressure.

Government intervention

  • To increase consumption, the regime issued a “Notice on Expansion of Consumption” (commonly known as “Twenty Articles”), but since there are no subsidies or consumption vouchers, it hasn’t had much effect.
  • China’s fixed asset investment increased by 3.4% from January to July, but the private investment portion of this decreased by 0.5% over the same period. This shows that efforts by the Party-state to engage with the private sector have not succeeded in restoring trust.

Chinese regulators have urged banks to lend more to developers so they can finish incomplete housing projects, such as the China Banking and Insurance Regulatory Commission (CBIRC). However, the massive oversupply in the real estate market may not be made up for the reduction in interest rates and down payment requirements.

  • Poor employment growth is a result of the problems faced by the private sector, which accounts for more than 80% of jobs in urban areas. This contributes even more to the consumption problem.

 

Effect on other nations

  • As a result of the slowing Chinese demand, exports and services have already decreased in Japan, South Korea, and Thailand.
  • As a result of the rising cost of labour in China, many businesses have already started moving their manufacturing operations to less expensive nations like Vietnam, India, and Mexico.
  • An increased highly educated labour force and a declining youth population could increase prices for consumers outside of China, potentially escalating inflation in nations that heavily rely on imported Chinese goods.
  • Lower Chinese demand could result in a spike in commodity prices, including oil.
  • A declining population would also result in lower consumer spending in China, endangering international brands of everything, ranging from sports equipment to smartphones.
  • A slower China means less demand for imports of goods and other commodities, as well as fewer Chinese investments and influence in regions like Africa that are influenced by geopolitics. Additionally, it would be detrimental to the Belt and Road Initiative (BRI) participating nations. It has been reported that Italy is already developing a new foreign policy initiative to restrict technology transfers to China. Additionally, Italy recently declared its intention to terminate the BRI agreement because “expectations were not met.” Italy was the only member of the G7 to have participated in the BRI, so this could be detrimental to China’s plans.
  • Despite this, China continues to invest heavily in its military; it has a strong global diplomacy; and it participates in economic agreements which the United States does not entertain. Another indication that China’s diplomacy is still going strong is the fact that more nations want to join BRICS. The spillovers will only affect the trade channels because China’s financial markets are not as well connected to the rest of the world as its trade sector.

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