China is experiencing symptoms of Japanese-style stagnation, characterized by falling property prices and declining exports. At the same time, there has been a marked surge in growth in service-oriented industries and advanced manufacturing.
The divergence between economists close to the government and politicians in Beijing over the need for additional economic support has led to a conflict of interest, potentially hindering the unlocking growth potential.
Positive Momentum Due to the Lifting of Coronavirus Measures
There was a favorable turn of events early in the year when stringent coronavirus measures were lifted by the end of 2022. This led to a rapid recovery in consumer spending and positive momentum in the emerging real estate sector. However, this surge proved to be short-lived. According to recently released official data, the second quarter saw a modest 0.8% quarter-on-quarter growth in gross domestic product. Additional data showed that the slowdown persisted throughout July.
The world’s second-largest economy does not face the possibility of entering a recession. While sluggish, the growth rate in the second quarter was 3.2% year-on-year, surpassing the 2.4% achieved by the US over the corresponding period. However, this result was disappointing in light of earlier forecasts by investment banks, which had pointed to annualized growth rates of more than 6%.
The Fall in the Real Estate Market Played a Significant Role
One factor contributing to disappointment is the slump in the real estate market: The fall in the real estate market, which began in 2021 due to government measures aimed at easing financial instability and debt, took a new turn in the second quarter. Home sales were down 18% from a year earlier in June, and housing activity was down 10%.
This significantly impacts economic growth, as the real estate sector and related industries, including steel and home furnishings, contribute about 20% to GDP. A significant decline in Chinese exports to Europe and the US affected the second quarter’s performance. On the positive side, there was a marked increase in service utilization, with spending at establishments such as bars and restaurants up more than 20% compared to last year. In addition, air travel exceeded pre-pandemic levels.
Over the past two decades, China’s thriving housing sector has consistently contributed significantly to its economic recovery. However, the current scenario deviates from this trend. This anomaly indicates weakening confidence in businesses and consumers: Convincing oneself of economic well-being becomes difficult in a volatile housing market, as historical examples point to its association with the financial crisis.
Households Continue to Build Up Their Savings
The lack of confidence, reflecting the impact of prolonged restrictions and regulatory measures associated with the pandemic, has resulted in households tending to increase their savings beyond pre-pandemic levels. At the same time, many businesses have been hesitant to engage in investment activities.
Economists look to international landscapes for comparative analysis in search of unusual circumstances. Considerable attention is paid to drawing parallels with Japan in the 1990s, when the real estate bubble burst, leading to a long phase of sluggish economic expansion.
There are also traces of Japanization in price data. China’s GDP deflator, a composite indicator of inflation, turned negative in the second quarter, only the third instance in the last century. Japan’s experience shows that deflation can negatively affect consumer demand and act as a disincentive to investment due to rising corporate debt servicing costs.
Upon further examination, however, it becomes apparent that there are as many differences as similarities between Japan and the region we are considering. First, China has seen significant growth in many important industries, such as electric vehicles, batteries, renewable energy, and high-speed trains, primarily due to extensive government support. In the first six months of this year, there was strong growth in the production of all saws, showing double-digit growth. At the same time, there was a marked increase in investment in capacity building, and saw exports rise sharply.
How Sustainable Are the New Economic Sectors?
The question is whether this dual economic situation is sustainable. The optimistic view, advocated by some government-affiliated economists, is that the resilience of the so-called new sectors of the economy can offset the downturn in the real estate sector. A downturn in the housing market could hurt consumption, which would require government intervention in the form of stimulus measures. The argument above won out after a slowdown in consumer spending growth in July.
Wall Street economists are adjusting China’s economic growth forecasts 2023 to more closely match Beijing’s official target of around 5%.
Agreeing only to that target suggests that President Xi Jinping and economic policy advisers have recognized that the end of the real estate boom will bring China’s growth rate down from pre-pandemic levels. In contrast to the US, substantial fiscal stimulus has allowed a higher growth trajectory to emerge in this country, although the duration of this momentum remains uncertain.
China’s Second Quarter GDP Grew by 3.2% Annually.
Advocates from the ex-official and government-affiliated economist community have advocated for an expedited increase in governmental expenditures to fortify household income and stimulate property sales.
It is argued that the central government can borrow at relatively modest rates, primarily due to China’s unique position unaffected by elevated inflation levels, unlike other nations globally. There is potential for implementing monetary easing measures, as evidenced by the limited adjustment made to interest rates by China’s central bank throughout the current year.
According to Michael Hirson, a former US Treasury attaché in Beijing, arguments of this nature have had minimal influence, as pleas for substantial stimulus are deemed “politically incorrect.” The notion of “high-quality growth” has been consistently emphasized by Xi, suggesting the necessity for the nation to reduce reliance on the property market as a predominant catalyst for economic expansion.
However, indications have emerged in recent times that the political equation might be transforming. During a midyear gathering, the Chinese Politburo, led by Xi, expressed their commitment to implementing a “countercyclical” approach, a strategy previously employed in 2019.
This includes an accelerated implementation of infrastructure investments. Furthermore, an initiative to support the private sector has progressed beyond mere rhetoric, as government officials at various hierarchical levels consult with corporate executives, encouraging them to propose policy recommendations.
However, it is anticipated by economists that Beijing will refrain from significantly surpassing its growth target due to ideological and political factors. Implementing direct payments to households is deemed unviable, partially due to concerns surrounding the potential promotion of reliance on welfare. Moreover, the central government of China exhibits a relatively modest size, necessitating the redirection of fiscal assistance through provincial administrations.
Negotiations are underway between Beijing and various provinces regarding restructuring accumulated debt from previous years. It is improbable for Beijing to provide direct monetary assistance amidst this ongoing process. According to Carlos Casanova, the chief Asia economist at Union Bancaire Privée, economists often state that the concept of a free lunch does not exist. Therefore, the price is currently under discussion.