China’s economy reopened following Covid-19 pandemic lockdowns with a wave of optimism of how pent-up consumer spending would be unleashed and bring about an economic rebound. With Chinese households building a collective Rmb6tn ($841.3bn) in excess savings in 2022, the hope was this excess cash would result in a boom in retail spending, fuelled by the Lunar New Year, as consumers resumed discretionary spending.
The initial signs were promising: the National Bureau of Statistics (NBS) reported year-on-year spending in January and February 2023 was up 3.5%, a rebound from negative figures recorded during the last quarter of 2022. The numbers have continued to steadily increase to 18.4% in April 2023, but overall fall short of the anticipated big bang in consumer spending.
Violet Chung, senior partner at McKinsey in Greater China, holds an optimistic view: “Economic growth has outperformed expectations and market demand is gradually recovering. In the long term, China still possesses advantageous conditions, such as a massive market size, a complete industrial system and abundant human resources for further development.”
Ms Chung believes there is a general positive outlook on the market. Cross-border trade expanded by 7.4% in March and exports increased 14.8% year-on-year. Consumer confidence has seen an increase from 91.2 index points in January 2023 to 94.7 in February. Consumer price inflation dropped from 1% in February to 0.7% in March.
Economic growth has outperformed expectations and market demand is gradually recovering
Yet there are signs of trouble brewing. In June 2023, the People’s Bank of China (PBoC) took steps to stimulate the economy, announcing a cut to the seven-day reverse repo rate from 2% to 1.9%, with the aim of increasing liquidity. It is expected this will be followed by further monetary easing and stimulus measures. With the goal for gross domestic product (GDP) growth set for 5% in 2023, additional measures may be needed to reach this target.
Jinny Yan, managing director, chief China economist at ICBC Standard Bank, says: “Although retail sales have started to recover, I would call it a replenishment or rebound rather than recovery. Replenishment would mean getting back to pre-Covid levels, and to recover beyond that may take further policy support and impetus.”
Structural change
Is China’s slowing growth such a cause for domestic concern? As international investors expect the country to see its growth rate restored to the almost double-digit levels seen in the immediate pre-pandemic years, the story within China is one of mediation.
“Prior to the pandemic, we had seen a structural slowdown as the economy adjusted away from investment- and infrastructure-led growth,” Ms Yan says. “With demographic challenges, we are likely to see a gradual slowdown in GDP growth, regardless of economic cycles.
“Since China’s official reopening in December 2022, we have cautioned against sentiment outpacing fundamentals, as economic data has not yet matched expectations,” she adds.
The foreign investment markets had looked to China’s reopening as the catalyst for the global economy to fully rebound, especially as challenges such as the war in Ukraine have curtailed international growth, Ms Yan says.
“There have been high hopes that China’s recovery would offset sluggish growth in other major economies, but this hasn’t yet materialised,” Ms Yan says. “This is in part because China is still experiencing its second Covid wave. This is an additional weight on confidence, meaning consumers are more likely to save than spend, and corporates are cautious on investments.”
The growth of China’s GDP is not the main focus of the Chinese government
Chan Kung, founder of China-based think tank Anbound, explains bluntly: “The growth of China’s GDP is not the main focus of the Chinese government, which is a significant departure from the past. Many people have difficulty adapting to this, and even find it to be unbelievable, which has led to potentially severe consequences.
“Some observers note the apparent contradiction between China’s political and economic performance, making it challenging to explain such a paradoxical situation. In reality, this contradiction arises because politics takes precedence as the primary government objective in China, while the economy does not hold the same level of importance. As a result, it is anticipated that China’s GDP growth will persistently hover within the range of 4% to 5% in the long term. Such a growth rate implies that the Chinese economy will slip by over half, compared to most of its previous periods.”
But is this tempering of expectations planned, or is it a direct result of a cooling economy? The lingering effects of the long-term Covid restrictions have caused a deep fissure in the economy, according to Yu Lingqu, vice-director of the department of financial development and state-owned assets and state-owned enterprise research at think tank China Development Institute. He says the impact runs deep.
“In China’s banking and economy, China does not have enough credit lending demand, and we call this the ‘scar effect’,” explains Mr Kung.
“This scar effect is, after Covid, companies with reduced risk preference are reluctant to spend and invest into their businesses. Consumption has not returned to high rates, so companies are not optimistic. In April 2023, China’s consumer price index growth was only 0.1%, but in the US it was 4.9% and in the UK it was 8.7%. The consumption and investment demand in China is still low.”
There is a reliance on the consumer sector to support growth, as the challenges in other areas are restricting other contributors. “Previous episodes of rebound in sentiment had been largely driven by the property sector, but we do not get that sense now,” Ms Yan says. “Consumption and spending patterns have reflected a more cautious stance, and we have seen … a shift away from luxury purchases towards everyday staples such as food and welfare. There is a reluctance among households for excessive spending due to uncertainty over household income, job prospects and by how much wages will increase.”
Employment levels stall
These concerns about household income are not unfounded. Employment figures have remained stubbornly low, despite the reopening of the economy. Figures from the NBS for April 2023 showed urban unemployment was 5.2% — a slight decline on the 5.3% recorded the previous month. Among 16-to-24-year olds, unemployment reached 20.4% in April 2023, an increase from 19.6% the previous month. The government has a target jobless rate of 5.5% in 2023, and a goal to create 12 million urban jobs.
“As China’s population ages, we see record numbers of fresh graduates entering the labour market and not being able to find jobs, especially ones that make the most of their skill sets,” says Ms Yan.” We are likely to see a longer-term impact on productivity if these graduates continue to be underutilised.”
China’s aims of moving manufacturing up the value chain appear to be stymied by a lack of highly skilled jobs. There has been a knock-on effect from geopolitical tensions.
“The US has been imposing sanctions on Chinese science and technology companies. Since the increased tariff on some Chinese companies, we have seen them move production to south-east Asia. If these relations continue to worsen, we will see this trend increase,” says Mr Yu.
While the production of low-value consumer goods manufacturing exiting China has been part of a longer trend, recent years have seen the manufacturing of automobiles, solar panels and electric vehicles (EV) moving from neighbouring Vietnam and Thailand to countries closer to the end-consumer markets, such as Poland and Mexico.
Ms Yan says China’s development risks stalling without quality industries. “Being stuck in the so-called ‘middle-income trap’ has been a cause for concern for many economists. China may follow a similar path to east Asian economies, but one of the biggest challenges is China’s sheer scale. The world’s largest population is shrinking and ageing at a faster pace than many had anticipated. To offset a potential structural slowdown, China needs to tackle the productivity gap in order to prepare for the next stage of economic development — one led by innovation and technology.”
With the continuing uncertainty, consumers are prioritising paying down debt over making big ticket purchases. “There is a sluggish response from the household sector,” says Nicholas Zhu, vive-president and senior credit officer at Moody’s Investors Service. “We saw some rebound in tourism and food and beverage consumption, but not in housing or automobile purchases. Households are putting aside savings easily into deposits, and using excess liquidity to pay off debts and mortgages; we are seeing sizeable prepayments for the first time in many years. It signals continuing caution from households. In relative terms, the corporate demands for loans have been much stronger.”
Property sector
The number of households paying down their mortgage debts is causing more worries for the real estate sector, which was recovering from the Evergrande crisis in 2022.
Cuts to mortgage rates to stimulate the property market have encouraged households to pay off mortgage debts, but have in turn impacted bank profits on mortgages, which accounts for up to 30% of total outstanding bank debt.
The difficulties are reflected in housing costs. Property prices saw an increase of 0.1% in May 2023, according to the NBS, marking the first time prices have risen since April 2022. There is a mixed outlook across China’s four tier 1 cities, which are broadly recognised as the country’s most affluent and densely populated. While Beijing saw prices rise by 4.3% in May compared with the previous month, and Shanghai by 4.9%, Shenzhen saw prices decline 0.2% and Guangzhou fell by 0.4%. With these pressures on the market, lenders have taken steps including extending the upper age limit on mortgage lending to 70 years of age, with unpaid mortgages given on a 10-to-15-year term to be passed on to the next generation.
In a country where rising house prices are integral to consumer confidence, it has a ripple effect across the retail sector. Ming Tan, director at S&P Global Ratings, says: “Property continues to be a pocket of stress and will weigh on demand. There is less confidence in the property developers and housing price appreciation, which has been well-entrenched in Chinese households. This will impact household confidence and their spending.”
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The government has moved to support the embattled sector, when in November 2022 the China Securities Regulatory Commission opened up financing for developers, such as permitting private share sales and allowing mergers. The PBoC and the China Banking and Insurance Regulatory Commission also introduced measures including requiring banks to roll over loans to the property sector, extending mortgage payment periods and lowering deposit requirements.
The relaxation of the rules provides some slack to the market, says Mr Yu. “The regulation on house purchasing is quite strict, with the down payment at around 50% of the total price.”
There are suggestions of additional steps, but they need to be decisive. Alicia García-Herrero, chief economist for Asia-Pacific at Natixis, says: “We expect growth to remain underwhelming for 2023 unless the real estate-related stimulus that China’s policy-makers are mulling is very large.”
Getting the property sector back to full health is a key concern, says Grace Wu, head of greater China bank ratings at Fitch Ratings. “The pace of recovery in China’s housing market will have implications on macro policies and monetary stance,” she says. “Without a sustained recovery in housing transactions, the debt restructuring efforts at troubled developers will not result in long-term improvement in their financial positions, and this could lead to a longer-term impact on China’s economy.”
Regional pressure
In a country as vast and populous as China, the pressure on regional governments varies considerably. While the overall economy is showing signs of improvement, across the country it is fractured, with the wealthier, urban areas overcompensating for the struggles in the poorer regions. The tandem impact of the pandemic and the decline of the property sector has heavily affected some areas.
“China has some regions that are quite heavily indebted, which is pressuring local government finances. This is another potential pocket of stress we are monitoring,” says S&P’s Mr Tan.
It is a view echoed by Fitch, which issued a note in January 2023 on the attempts by the authorities to prevent a crisis of defaults on local government financing vehicles (LGFVs) in poorer regions. Using the example of the restructuring plan for Zunyi Road and Bridge Construction Group, Fitch outlined the “unusual” structure, as it extends the Rmb15.59bn in bank loans by 20 years, with reduced interest rates and no principal repayments for the first 10 years. “The arrangement indicates the company’s expectation of weak cash flow relative to the debt-servicing burden over the long run,” Fitch states in the note.
Natixis similarly raises concerns, stating in a note from May 2023 that LGFVs are considered as off-balance sheet debt. Natixis states that, as there is no clear definition of LGFVs, it is difficult to identify the entities, and public disclosure of the debts is incomplete. It is noted that the government can reallocate resources to support debts, but the accumulation of public debt could hurt growth rates over time. “While we expect China’s public debt burden to increase further, weighing down on potential growth, debt sustainability may not be a problem. Still, among all types of public debt, LGFV debt could be particularly concerning as these vehicles may not have an explicit official guarantee from the central or local governments.”
The debt levels seen across some provinces are sizeable. The worry is how widespread these issues could be. “Regions like Guizhou and Gansu are under pressure,” says Mr Tan. “We are concerned that some regions’ tier 2 and 3 governments could also be vulnerable.”
Guizhou, for example, has enlisted the help of China Cinda Asset Management to tackle its debt, which stood at Rmb25tn at the end of 2021, including Rmb1.31tn in hidden debt, according to the most recent estimates from CSPI Credit Ratings.
Across China, different provinces have different goals, and they are usually higher than the central government
Still, some commentators do not believe the issue to be of significant concern. “In areas such as Guizhou province and Yunnan province, their local debt issue may have bigger financial risk, but if you look at China as a whole, they take up a small part of the economy and will not pose a financial risk to China,” says Mr Yu.
There are attempts to revitalise the industries of some of the struggling provinces. The north-eastern region, comprising Liaoning, Jilin and Heilongjiang provinces, is undergoing a period of economic transformation as it looks to move away from its ‘rust belt’ image. The region is dependent on heavy industry, and as China moves towards greener energy and production methods, the region risks being left behind without alternative forms of employment. Huge projects have been announced, including a Rmb600bn investment into the creation of wind, solar, nuclear and hydrogen energy stations to be constructed in Liaoning province by 2030. As well as helping China towards its green energy targets, it is hoped these projects will create high-quality jobs.
Ensuring a return to growth could lie in setting targets on a localised level, rather than from the central government. “Across China, different provinces have different goals, and they are usually higher than the central government,” Mr Yu says. “In Shenzhen, the GDP goal rate is set at 6%. The economic growth and industrial upgrade in China is highly localised, leading to higher goals and greater optimism about their economic growth rates. In EV production, Shenzhen-based car manufacturer Build Your Dream will double its output this year. Last year, 1.8 million vehicles were produced and this year’s forecast is 3.6 million.”
While ambitions may run high, the overall picture emerging is of an economy looking to tackle multiple issues simultaneously, while maintaining the outlook of strong economic growth. Although the government may intervene to support sectors, significant restructuring may be needed at the local government and real estate level to ensure these issues do not spiral out of control.
