China has a China problem.
The world's second-largest economy has often unsettled others with its unparalleled edge in manufacturing, exports and investment financing. But now, its own economic policies have pushed large sectors like the property market onto the fainting couch, while the economy is being hauled into the sick bay by a triple whammy of high unemployment, low growth and deflation.
If the beginning of 2023 held optimism about a rapid recovery, the latest data dispatches make only one thing clear: the numbers aren't with them.
In China's defence, economic data does seem to be hell-sent. A sequential GDP growth rate of 0.8% in Q2, 2023, low inflation sparking deflationary fears, a record high youth unemployment rate of over 20% for three months in a row, contraction in the mighty manufacturing sector stretching to five months in July, FDI plunging by 87% in Q2, the largest decline since 1998 when data first became available, and so on.
Call it numerophobia, or something else, China's particular dislike for bad numbers is evident from its recent actions such as suspending the publication of unemployment data and reportedly warning experts to avoid saying things as they are, in the event of negative data, and instead compare it with care.
Beijing admittedly is aware of the "new difficulties and challenges" and rolled out a 31-point action plan, but is yet to bring out the big guns (fiscal stimulus) without which, experts fear, the economic slump may get deeper and longer. Such a prospect must be avoided as China accounts for 22% of the world's GDP according to the IMF and will have a reverberating effect on the global economy, pounding everything in its way from commodity prices to equity markets to currency rout to even financial instability.
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One can perhaps withstand a momentary lapse in China's growth story, but the biggest concern isn't about the ongoing slowdown. Rather, the dreadful question is whether China is headed for a Japan-style malaise after 30 years of unprecedented economic growth. Optimists believe the ongoing correction may help China transition with a different strategy comprising steady growth over stratospheric rise, and focusing on qualitative output than quantity.
Property slump
China, which has been juicing up its economy building ghost towns and airports, is now facing what US President Joe Biden termed as a “ticking time bomb." Decades of government stimulus encouraged reckless property development leading to oversupply. Private developers and local governments borrowed extensively to fund projects, kicking off a real estate bubble. Supply outstripped demand as China extended its lockdowns that were lifted only in December 2022.
But as economic slowdown and rising unemployment sparked fears of uncertainties, the real estate sector began getting the chills. In July alone, home sales of the top 100 developers fell by 33.1% y-o-y and developers are worried about defaults, given the country’s ongoing credit crisis. China's central bank, the People's Bank of China, has cut rates twice in the past three months, in a complete departure from the rest of the world that's living through rate hikes, but the reductions were too small to make any meaningful difference.
Falling sales and consumer sentiment forced the country's largest real estate developer Country Garden to miss two bond payments aggregating $22.5 million early this month. Thanks to a 30-day grace period, it's now suspended between solvency and default. For a realty developer with $194 billion liabilities on its books as on 2022, $22.5 million is chump change. But its inability to pay on time sparked fears of an inevitable default, forcing the stock to slump, bonds to trade less than face value, followed by credit rating downgrades. In reality, the issue began with the $22.5 million missed payment, but bigger worries ensued about offshore debt in excess of $1.4 billion that's set to mature between September and January.
Investors are fearing another collapse like that experienced by China's Evergrande Group, which went under following a debt default in 2021. According to Morgan Stanley, Country Garden is burning 3-4 billion yuan in cash each month just to stay afloat. Country Garden has four times as many projects as Evergrande and is largely located in third-tier cities, some of which are lying empty. Its collapse could spark fears of an economic contagion.
Besides the property market, there are fears of a financial contagion coming from shadow-banking firm Zhongzhi Enterprise Group. With assets over 1 trillion yuan, it’s one of the biggest trusts in China and drives much of the country’s finance industry. Chinese trusts pool money from household savings and are involved in property development, bonds, equities, and commodities. Operations of these entities are shrouded in secrecy, but market watchers sense it's the next financial fire waiting for the match to light it.
An even bigger problem persists with China's local governments, whose overbuilding not only led to the property market slump, but also weighed themselves down under a $23 trillion unmanageable local government debt. Reportedly, Goldman Sachs estimates the total local government debt pile at $13 trillion, including the liabilities of the off-balance sheet entities known as local government financing vehicles.
Amid weak economic indicators, a collapse of the real-estate sector could plunge the country into a recession as the property market accounts for about a quarter of economic activity. Last year saw protests across 100 cities as mortgage owners demanded that developers finish projects. Will Beijing announce more stimulus to bail out developers and prop up the economy, or let the real estate bubble burst risking a deeper economic slowdown? There are no easy answers as either way the government may have to bear consequences.
Unemployment
The one major indicator that got the world's attention, besides China's realty woes, includes youth unemployment. While China has been grappling with it for some time now, the latest numbers indicate the intensity of the issue. In June, youth unemployment hit a record high of 21.3%, which means about one in five of China’s 16- to 24-year-olds were jobless. The unemployment rate stayed above 20% for over three months since April, when it touched 20.4%.
Perhaps, intimidated by all the social media surveillance, a miffed Chinese government indefinitely suspended the official publication of data early this month. Without giving details, the National Bureau of Statistics (NBS) said it would no longer release age group-specific unemployment data starting August and added that there was a need to “further improve and optimise labour force survey statistics.”
Policy commentators believe the decline in job creation was partly on account of a regulatory crackdown on large private enterprises, particularly on companies such as Tencent and Alibaba, and others in the technology, education, real estate and finance sectors. As per estimates, the private sector accounts for 60% of GDP and 80% of urban employment.
Economy
China's $18-trillion economy is declining. And in the absence of government intervention, estimates have been dire. Goldman Sachs projects China’s economy to be 67% the size of the US economy this year, down from 76% in 2021.
A slew of disappointing economic data confirms that the struggle is real and spread across sectors. GDP growth barely grew by 0.8% in Q2, 2023, and the July economic activity data has prompted economists to believe that the 5% annual growth target is impossible to meet without fiscal stimulus.
Some are terming it a balance sheet recession, a period when consumers opt for debt repayments instead of spending or investing, while businesses favour debt minimization over profit maximization. In such instances, economic growth will be stalled, as witnessed in Japan’s descent into a period of low economic growth and low inflation in the 1990s.
What happens to China is crucial, as it contributes over 22% of the world GDP according to the IMF. As for China's ambition to overtake the US as the world's largest economy, the hour grows late.
It's not the first time that China's economy is seeing a slump. It has survived similar episodes earlier such as the 2008-09 global financial crisis. And each time, China emerged relatively unscathed, and its economic bazookas became bigger and bolder. Policy watchers, however, believe it's different this time.
Given its debt-fuelled infrastructure investments are loaded to the gunwales, and as exports are showing signs of strain, the only other avenue left untouched includes household consumption. As a percentage of GDP, household consumption has been traditionally among the lowest in the world even before Covid, and it's this key structural imbalance that China may want to work on. As per one estimate, the imbalance between consumption and investment is even deeper than Japan's before it entered its "lost decade" of stagnation in the 1990s.
It's this weak domestic demand, coupled with subdued investment appetite, which is seen as one of the reasons for China sliding into deflationary zone.
Deflation
Consumer prices saw their first annual decline in more than two years in July, while the producer price index moderated to 4.4% from a 5.4% decline in June, official data showed. Core CPI, excluding food and energy prices, rose by 0.8% -- the highest since January.
While lower prices are delightful news for consumers, they are actually bad for the broader economy. Low inflation, or deflation -- when prices begin to decline across the broad economy -- is a sign of weakness. While it increases the purchasing power, deflation also puts downward pressure on business profits, pushes down wages and employment and reduces the incentive to invest in capacity creation.
Importantly, the real value of debt goes up and borrowers may feel the pains of debt servicing during deflationary episodes. Significantly for China, given several businesses and local governments have extreme debt loads, deflation may complicate their problems.