Deflation, troubling exports add to China’s economic malaise
Towards the end of 2022 and until the beginning of this year, market observers had predicted that the global economy would experience a slowdown in 2023. Forecasts of the International Monetary Fund (IMF) in January 2023 showed that global growth would be 2.9% against 3.4% in 2022. The growth projection for advanced economies was 1%, slowing down from 2.7% during the previous year, and 1.4% for the USA against 2% in 2022. In contrast, the second-largest economy, China, which had decided to discontinue its zero-Covid policy earlier in the year, was expected to grow at 5.5%. The country was to benefit from releasing “pent-up” demand after ending the draconian Covid-era restrictions.
Six months later, the global growth scenarios look very different. According to the IMF, advanced economies may grow faster, by 1.5%, while the US could expand by almost 2%. On the other hand, China, beset with deflationary pressures, could register a sub-5% growth, and this can get worse if the Xi Jinping administration cannot quickly fix the many loose ends that have caused the economy to go into a tailspin. If China cannot address its malaise soon, the global economy could be in peril as, according to IMF estimates, China is likely to contribute almost 35% to global growth in 2023.
Since China had set out to capture the global economy under Deng Xiaoping’s leadership, it had deftly used both the global markets and its domestic economy to ride the waves. It was the most successful among the East Asian economies in using trade to drive the economy. In less than three decades, in the early 1980s, China increased its share in global trade from below 1% to 10%; its share in global exports
was even higher. No other country in recent history could leverage global demand to bolster its economy to the extent that China has done. From the late 1980s, while the Washington-based multilateral financial institutions were selling the virtues of using trade as an engine of growth, one of their strongest critics was proving them right.
But when the economic recession in 2008, triggered by the US subprime crisis, caused the worst global economic meltdown since the “Great Depression” of the 1930s, China quickly turned its attention to leveraging its domestic economy to maintain its growth momentum. Beijing launched a two-year, 4-trillion-yuan stimulus package in October 2008 to stimulate domestic demand, which could reduce its dependence on the global economy. In other words, the government sought to shield the Chinese economy from the impact of the global financial crisis. As a part of this package, local governments were directed to invest 2.2 trillion yuan, especially for building infrastructure.
The local governments established the so-called local government financing vehicles (LGFVs), the local government-owned companies that fund and construct infrastructure projects and operate in the public sector. In 2014, the National People’s Congress allowed the local governments to issue bonds, but only for financing infrastructure projects. Local governments used this enabling measure to dip into the financial market, which they did well in the subsequent years. However, the increased pace of borrowing led to rapid debt accumulation by the local governments that have assumed catastrophic proportions in the aftermath of the pandemic. A major contributory factor in the debt build-up was the steep decline in the revenues of local governments resulting from major tax cuts implemented in response to the
economic stagnation caused by Beijing’s zero-Covid policy.
According to China’s finance ministry, local governments had 35 trillion yuan in outstanding on-the-books debt at the end of 2022, including regular and special-purpose bonds for infrastructure projects. After adding the debt accumulated by the LGFVs, the total debt was nearly 100 trillion yuan or almost 80% of China’s nominal gross domestic product. This implies that China’s strategy to reflate from the 2008 economic recession by using the spending power of the local governments is no longer an option, at least for the near future.
Coping with the deflationary pressures has become a struggle for China as its exports have steadily declined by 5% during the first seven months of 2023 on a year-on-year basis. China’s exports to its most significant destination, the US, have declined by nearly 19%, while its exports to the EU member states and India have declined by 9% and over 2%, respectively. China’s exports to the ASEAN region, its largest market since its emergence as an export powerhouse, have declined by 2%. Like in the case of reflating the domestic economy using local government spending, which is not an option in the months ahead, prospects of using the global economy to resolve its present economic malaise do not look promising for China.
This is because of the fact that during the first seven months of 2023, all major economies have experienced sluggishness in global trade. Total trade of the second largest trading nation, the US, has consistently been in the negative territory since March, with its average import growth on a year-on-year basis being close to 9%. It does not look encouraging for an economy whose growth is fuelled by imports.
Other major economies, including India and the European Union, have also been experiencing headwinds, which do not augur well for the global growth prospects in 2023. Thus, although the IMF and several other commentators have predicted better global growth prospects for the current year, China’s economic woes indicated otherwise.
Dr Biswajit Dhar
Former professor, Jawaharlal Nehru University and Vice President, Council for Social Development
(bisjit@gmail.com)