China’s economic performance falls short of expectations

Thu, 03rd Aug 2023

Economic data released last week by the National Bureau of Statistics revealed that China’s economy experienced a noticeable loss of momentum in the second quarter. Although headline real GDP growth stands at a decent level of 6.3%, it was distorted by a low base effect stemming from lockdowns over the same period last year. Two-year average year-on-year growth, which effectively eliminates such effects, only reached 3.4%, down from 4.7% in the first quarter. The softening momentum is echoed in the slowdown of seasonally adjusted quarter-on-quarter growth, which reached just 0.8%.

Looking at the data broken down by sector, property remains the biggest drag on the economy on a sectoral basis. Despite already-low bases of comparison, the downturn was broad-based across the property value chain including in new housing starts (down by 24.3% year on year in the first half of 2023), area of new homes sold (-5.3%), and fixed-asset investment (FAI; -7.9%). Further, in a sign that official data misrepresented the actual amplitude of declines, the slump in growth data derived by the EIU from FAI as reported by the NBS (-14.3%) was far steeper than the officially announced FAI growth figure (-7.9%). The two series were closely aligned until March 2023; the emerging discrepancy thereafter may indicate a bleaker reality than official figures suggest. As a result, we believe that a prolonged depression is far more likely than an imminent rebound.

Second, factory performance, albeit not stellar, nonetheless exhibited resilience. In June, industrial value added (IVA) among above-scale (large) enterprises expanded by 4.4% year-on-year in real terms, marking an acceleration in production in line with the stabilisation of the manufacturing purchasing managers’ index for June. Although our pessimistic projection for the property market (a major source of demand for industrial goods) will still weigh on the IVA, this will be partially offset in the second half of the year by improvements elsewhere including a forthcoming cyclical recovery in the global electronics sector (IVA in the communications and electronics industry grew by just 1.2% in June), an export-driven expansion in automotive production, and the gradual mitigation of excessive capacity as manufacturers digest stocks.

Third, although the first half of 2023 saw a reasonable recovery in real household disposable income, which expanded by 5.8% (higher than real GDP growth over the same period), in June, the CPI (0%) moved to the cusp of deflation territory, a rarity in China outside of the holiday period or covid-related disruption. Whereas the CPI reading is usually heavily influenced by the supply of pork, a crucial source of dietary protein in Chinese households, weak core inflation reveals stresses in demand. This is in line with our view that the rebound of consumption this year comes primarily from a low base and the enduring impact of the pandemic. Even more troublesome is that, based on historical experiences of deflation/low inflation in the US during the Great Depression (1929-1933), Japan (1998-2012), and the Eurozone (2014-2016), when low inflation/deflation stems from insufficient demand it tends to be accompanied by a series of adverse economic changes including declines in credit growth, decreased investment and consumer spending, lower economic growth rates, rising unemployment rates, and declines in stock and real estate prices. (This also theoretically and empirically explains many of the recent economic shifts that have been garnering widespread attention.)

The data as well as depressed CPI readings serve as an alarm to the government that without appropriate action it could be a challenge to achieving the growth target. As a result, on July 19th the central committee of the CCP and the State Council, China’s top policymakers, issued a joint statement supporting and vowing to boost confidence in the private sector. Although the EIU does not expect the statement to be followed by concomitant institutional or legislative changes, nor do we believe that it will fundamentally change the government’s emphasis on the state sector with respect to fending off perceived national security threats, the document will lead to shifts in government practice in ways that create a more benign and predictable operating environment for private enterprise. We therefore believe that governments across different levels of the bureaucracy will prioritise with greater seriousness and urgency the following remedial actions:

Promptly disbursing payables or arrears, delays of which have added to the financial pressures on private businesses;
Reining in practices that create unpredictability and increase operating costs including arbitrary administrative enforcement and excessive charges outside of statutory obligations of enterprises;
Softening the regulatory approach by staying firmly away from crackdown campaigns and even tolerating business conduct in grey areas; and
Granting more government purchase contracts to the private sector, which for security reasons has sometimes been side-lined in public tenders.

We also expect that at the Politburo meeting in late July, the country’s leadership will introduce measures to increase government spending and boost confidence, which should be sufficient to put the economy back on a recovery track.

Thu, 03rd Aug 2023 Article tags China Economy