According to the International Monetary Fund, this year was anticipated to be a turning point for the Chinese economy, expected to act as a global economic catalyst, as forecasted at the beginning of the year. The reopening of the Chinese economy after Beijing’s successful COVID-19 containment measures was even celebrated as the most significant economic event of the year by global financial markets. While it has indeed fulfilled some of those expectations and remains the most crucial economic event of the year, the reasons behind its significance are somewhat different.
The Chinese economy, the world’s second-largest after the United States, experienced a growth of 6.3 percent in the second quarter compared to the previous year. Although this growth rate appears impressive, it fell short of global expectations. In the second quarter, the economy only grew by 0.8 percent on a quarterly basis, significantly lower than the 2.2 percent growth rate recorded in the first quarter, amounting to an annualized rate of just 3.2 percent. Furthermore, several data points indicate a pessimistic outlook for the coming months.
The slowdown in growth can be attributed to a variety of factors, with one significant factor being China’s heavy reliance on exports. Unfortunately, the demand for Chinese goods has weakened due to the impact of higher interest rates in advanced economies. For instance, in June, China’s exports saw a staggering decrease of over 12 percent compared to the previous year, marking the largest decline since the peak of the pandemic in February 2020.
Furthermore, the Chinese economy faces another challenge in the form of reduced external demand for consumer electronics. During the pandemic, consumer electronics had been a pillar of support for Chinese industrial production, accounting for almost one-third of global industrial output.
The Economist highlights an important aspect in this context, pointing out that nominal growth in China was weaker than the inflation-adjusted figure. This has only occurred four times in the past 40 quarters, and indicates a downward trend in the prices of Chinese goods and services. In fact, during the year leading up to the second quarter, prices have declined by 1.4 percent, marking the largest drop since the global financial crisis.
Another obstacle is consumer confidence in China, which has been weakened since the onset of the pandemic, leading to a significant decline in retail sales and a prolonged period of decreasing new home prices, which are currently at their lowest point since records began in 2011. Moreover, the unemployment rate among Chinese graduates has surpassed 20 percent, contributing to a general sense of pessimism.
Furthermore, investment in business operations has been hampered by President Xi Jinping’s regulatory crackdown on technology companies in recent years and broader geopolitical tensions with the United States. These factors have created uncertainty and have had a noticeable impact on private investment in fixed assets, which contracted by 0.2 percent in the first six months of the year. Conversely, government-led investments saw growth of 8.1 percent, as reported by Financial Times.
Additionally, real estate investment, once a major driver of the Chinese economy for almost two decades, has lost its momentum. The property market in China has not performed as expected, with apartment sales plummeting by 27 percent in June compared to the previous year.
It is crucial to note that China’s financial landscape is strained, particularly considering the soaring local government debt, which has reached approximately $9 trillion, equivalent to about half the country’s GDP. With domestic demand remaining weak, servicing such a massive debt burden could lead to escalated actual costs.
It is important to highlight that China’s main annual inflation rate was 0.4 percent in June. Concurrently, the Producer Price Index continued its decline for the ninth consecutive month in June, experiencing a significant drop of 5.4 percent compared to the previous year, marking the largest decrease since December 2015.
Mohamed El-Erian, chief economic adviser at Allianz, has identified three primary factors contributing to the recent slowdown in China’s growth. Firstly, the latest trade data indicates that the global economy is no longer providing the necessary support for China’s domestic growth dynamics. Both exports and imports declined in June, falling by 12.4 percent and 4.1 percent respectively. This can be partly attributed to major trading partners in Europe also experiencing economic slowdowns, along with enhanced restrictions imposed against China by the United States.
The second factor lies in China’s dilemma in choosing between two approaches to stimulate its economy, resulting in an indecisive policy response. This comes at a time when local political challenges are exacerbating due to structural factors, such as an aging population and rising youth unemployment.
The third and final factor is that the easing of strict restrictions imposed by Beijing to combat the pandemic did not lead to widespread surges in demand for businesses and real estate.
El-Erian further emphasizes that China cannot solely rely on globalization to rescue its faltering growth model. Instead, he proposes that Beijing should focus inward and reorient its policies towards an efficient growth model.
The Chinese government is responsible for the economic slowdown. Financial Times points out that years of relying on an investment-driven growth model have hindered China’s transition toward a consumer-based economy. Inadequate supervision of the housing market has led to unsustainable lending practices, while political obstacles have hindered private companies. Strict COVID restrictions have also left lasting impacts.
To prevent a debilitating contraction cycle from becoming entrenched, the government needs to take swift action and provide clear regulatory guidance for businesses. Beijing must also undertake a restructuring of its local government debt, and one option might involve selling state assets to private companies. The revenues from such sales could help local authorities avoid a debt crisis, as reported by the Financial Times.
Despite this less optimistic outlook, most analysts expect the Chinese economy to grow above 5 percent this year, which means China will continue to lead the global economy, while the economies of the United States and Europe slow down.
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